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

  • pay staff wages and salaries
  • settle debts and therefore avoid legal action by creditors
  • benefit from cash discounts offered in return for prompt payment
Working capital is the current assets minus the current liabilities

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

working capital = current assets - current liabilities

Many groups of people are interested in the published accounts of a company. The information they provide may influence future decisions. For example, lenders will be looking at the solvency of a business. Rivals are interested in monitoring the profits earned by competitors.

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