Working capital is defined as the difference between a business’s current assets and its current liabilities listed on its balance sheet. Current assets are items that can be converted into cash over the short term while current liabilities similarly are obligations that need to be satisfied shortly.
Net working capital (NWC), calculated by subtracting current liabilities from current assets, is a measure of both short term liquidity and operating efficiency. Positive net working capital indicates adequate resources for a business to function and meet its operating needs, whereas negative NWC can indicate insufficient capacity to pay creditors.
Working capital management is an important management factor for businesses, but it also can be very nuanced, is constantly changing, as well as specific to the type of business being evaluated. As an example, high levels of positive working capital is not always a good thing and could suggest that either cash is not being utilized efficiently or there is too much inventory.
Lastly, in the context of a business transfer or sale, working capital is a key negotiating point as sellers typically want to take as much cash out as possible while buyers want some operating cash left in to run the business post-closing.
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