Working capital can be calculated as the variance between an entity's current assets and its current liabilities
. If the assets are less than the liabilities, it can be stated that the company is experiencing a capital deficit. Net capital is the value of its current assets minus its current liabilities minus cash available and minus interest bearing debts, which is short range debt.
In accounting terms, a current asset is one which is able to be sold within the near future, the time limit generally expected to be within one fiscal year. A current liability is a debt which is to be settled within one fiscal year or one operating cycle of the company.
Three vital accounts are contained in an entity's current debts and assets. Good management of this area is vital. The current portion of the liabilities is that which is to be paid within one year. This is most important as it clarifies what the short range requirement is to current assets and this is normally dependent on the long range assets. This short range requirement will include bank loans as well as any other short term debt.
When an entity experiences a growth in its working capital it means that it may have grown its receivables or other of its short range assets. It may also mean that it has lessened its short range debt by the settlement of some of it.
The management of this capital will cover immediate decisions that are based upon cash flow as well as profitability. Cash flow can be measured by the length of time from the outlay of cash required for raw materials to the exact time that payment is received for the goods. As the company's cash is tied up for this period, it is important to keep this time period to a minimum. The longer this period of time, the less cash flow there will be available for other business actions.
Capital management is one of the most important aspects of a business. Cash management in particular is vital as this is what enables the company to operate effectively and to be able to pay for daily expenditure. Stock management is also crucial. A good stock management system should be implemented to monitor stock flow. Work that is in progress should be kept at a low level and so should finished goods stock. This will assist with cash flow as it will minimize the amount of funding which is taken up with inventory.
The management of the debtor's book is crucial. A system of stringent debt control is required for successful cash flow. This will make sure that there is a constant flow of funds into the entity which will improve its working capital situation.