Applied Managerial Finance
Working capital is an accounting measure used to find out the financial efficiency, liquidity and the overall operation of a given company or simply the measure of how efficient the company is in relation to its financial growth in a short term time-frame. The reason to why working capital is used in determining the operations of the company, it is because working capital includes accounts payables, accounts receivable, inventory, cash and salaries payable. Working capital is thus the difference between current assets and current liabilities (McLeary, 2000).
- Explain what working capital is and provide an equation that can be
used to compute it.
The working capital concept plays an important role in financial management for a company as it is a term required for the operation of the company. For example, a merchant has goods which yields her no profit unless she gives them out for cash, and the cash brings her some profit till the cash is given out in exchange for goods. The working capital in accounting is necessary as it is required regularly for business operations. Such business operations includes the buying of raw materials, production activities, stock and store investment, paying of both direct and indirect expenditures, and inventories or credit given to customers who keep balance (Shweta, 2013).
In financial management, a statement (working capital) showing the flow of funds is calculated. The purpose of preparing the working capital statement is to illustrate its net effect on the flow of all funds in and out of the company over a period of time. Thus, the accounting equation can best be used to show the effect of funds flow on working capital. The equation therefore is:
Liabilities + Capital = Assets or
Current Assets – Current Liabilities = Working Capital
That is, L + C= A
The equation can further be expounded to: Current Assets + Long Term Assets = Current Liabilities + Long Term Liabilities + Capital
That is, CA +LTA = CL + LTL + C
The same equation can be read as CA – CL = LTL+ C – LTA
In addition to the equation above, in case there is any change in the working capital, the result will then be equal to all the sum of the changes on either side of the equation used to compute it. That is, ∆WC (change in working capital) = ∆LTL (long term liabilities) + ∆C (change in capital) – ∆LTA (change in long term assets).
- Compute the working capital for Apex
In computing the working capital of a given company, say Apex, one looks at the components on the balance sheet since all the components of the equation above appear on the balance sheet (Aswath, 2007).
Using the equation, the Apex Company’s working capital is:
Total Assets | 157,600 | 174,500 |
Total Current Assets | 20,450 | 14,500 |
Total Long Term Assets | 137,150 | 160,000 | ||
Total Current Liabilities | 18,100 | 11,200 | ||
Total Long Term Liabilities | 54,950 | 100,000 |
Total Liabilities and Stockholders’ Equity | 157,600 | 174,500 | ||||||||||||
000 $ | 000$ | |||||||||||||
2013 | 2012 | |||||||||||||
Total Current Assets |
| 20,450 |
| 14,500 |
| |||||||||
Total Current Liabilities | 18,100 | 11,200 | ||||||||||||
The difference 2350 3300
- Describe the trend and show whether the trend is improving, deteriorating, or moderating.
Form the balance sheet; it is evident to say that, among the current assets, the inventory takes the largest amount thus determines the gross working capital. In 2012 the inventory hiked from $6500 to $ 12100. This measures the average ability of Apex Company to manage its short-term obligations.
- Demonstrate the need for external capital.
As a result therefore, it can be deduced from the balance sheet that, the trend of the working capital is moderating as the current assets and liabilities from either years averages to the same as the other.
References
Aswath, D. Return on Capital (ROC), Return on Invested Capital (ROIC) and Return on Equity (ROE): Measurement and Implications. Stern School of Business Article, July 2007
McLeary, F. (2000). Accounting and its Business Environment. USA: Juta and Company Ltd.
http://books.google.co.ke/books?id=Xt2lLSi_qgIC&dq=explain+what+working+capital+is+and+provide+an+equation+that+can+be+used+to+compute+it.&source=gbs_navlinks_s
Shweta, M. Working Capital Trends and Liquidity Analysis of Fmcg Sector in India. IOSR Journal of Business and Management (IOSR-JBM) e-ISSN: 2278-487X, p-ISSN: 2319-7668. Volume 9, Issue 4 (Mar. -Apr. 2013), PP 45-52
http://www.iosrjournals.org/iosr-jbm/papers/Vol9-issue4/F0944552.pdf