How is working capital calculated and why is it important?

How is working capital calculated and why is it important?

• A. Working capital equals current assets minus current liabilities; it measures short-term liquidity and operating efficiency.
• B. Working capital equals current assets plus current liabilities.
• C. Working capital measures long-term solvency.
• D. Working capital equals net income.

Answer: (A)

Working capital is current assets minus current liabilities. This amount shows how much short-term cushion a company has to cover its everyday obligations using its short-term resources. A positive result means the firm can typically pay suppliers, employees, and other near-term costs without needing extra financing, supporting smooth day-to-day operations. It also reflects how efficiently the company uses its current assets—like cash, receivables, and inventory—to run the business. If working capital is low or negative, it signals potential liquidity problems and a heavier reliance on external financing to meet obligations. The other options don’t fit: adding current assets and current liabilities isn’t the correct measure, long-term solvency concerns are about longer-term debts rather than day-to-day liquidity, and net income is a profitability measure, not a liquidity measure.

Working capital is current assets minus current liabilities. This amount shows how much short-term cushion a company has to cover its everyday obligations using its short-term resources. A positive result means the firm can typically pay suppliers, employees, and other near-term costs without needing extra financing, supporting smooth day-to-day operations. It also reflects how efficiently the company uses its current assets—like cash, receivables, and inventory—to run the business.

If working capital is low or negative, it signals potential liquidity problems and a heavier reliance on external financing to meet obligations. The other options don’t fit: adding current assets and current liabilities isn’t the correct measure, long-term solvency concerns are about longer-term debts rather than day-to-day liquidity, and net income is a profitability measure, not a liquidity measure.