Working capital

A business is solvent if it can meet its short-term debts when they are due for payment. To do this it needs adequate working capital [Working capital: The difference between current assets less current liabilities - the difference between a firm's cash and its short-term debts - the money it has to play with. ].

There are 3 main reasons why a business needs adequate working capital. It must:

1. pay staff wages and salaries
2. settle debts and therefore avoid legal action by creditors
3. benefit from cash discounts offered in return for prompt payment

You can calculate a firm's working capital by using the following equation:

working capital = current assets [Current assets: Anything which could be converted into cash within 12 months. Current assets can include bank accounts, cash, stocks of raw materials and finished goods. They can also include debtors ie those who owe the business. ] minus current liabilities [Current liabilities: Any debt which has to be paid within 12 months. Current liabilities include all creditors, bank overdrafts and other expenses. ]