Working capital, or net working capital, is an amount of current assets subtract current liabilities. For example, a company has current assets of RM140,000 and current liabilities of RM80,000, its working capital would be RM60,000. Likewise, a business with current assets of RM80,000 and current liabilities of RM80,000 would not have working capital.
Current assets are the main components of working capital. Current assets are a company’s cash (Also see Accounting – How to Boost Your Cash Flow) and its other resources that could convert into money in one year.
Current assets consist of cash that is not limited to a long-term purpose. Current assets include the company’s other resources which would convert into money or would be used in one year from the date displayed in the heading of the company’s balance sheet. In unusual circumstances, the duration of the operating cycle is utilized in place of one year to identify the current asset when the normal operating cycle of a company is longer than one year.
• Accounts receivable
• Temporary financial investments
• Prepaid expenditures
Current liabilities are another working capital’s significant components. The definition is a business’s obligations that come due in one year.
Current liabilities are obligations of a company which are the outcome of a previous occasion that due in one year from the date on the balance sheet. In uncommon circumstances, the duration of the operating cycle is utilized in place of one year to determine the current liability when a company’s usual operating cycle is longer than one year.
• Payroll taxes kept from employees
• Loan primary amounts that come due in one year
• Wages payable
• Accounts payable
• Client deposits and deferred incomes
• Accrued expenditure or liabilities (repairs, interest, utilities)
A current liability should be reported as a long-term liability if there is a guarantee that a long-term liability would replace the current liability.
This is because the liability does not use the working capital of the company.
It is essential to understand the operating cycle to fully comprehend working capital, current assets and current liabilities. An operating cycle of a company is the average quantity of time taken by the company’s cash to be taken in the company operations and then back to the cash account of the company (Also see Basic Financial Ratios).
Below is an example explaining the operating cycle:
• Cash is used to buy inventory items.
• It normally takes 125 days to receive the items sold by providing credit terms, which are 30 days.
• Usually, the company obtains the cash from these consumers 50 days after sales took place, although the credit terms are only 30 days.
The operating cycle of the distributor is on average of 175 days.
If you require any further information regarding working capital, feel free to engage our accounting firm in Johor Bahru.