Business Tools Blog

Now that you know how the balance sheet works, you can calculate Working Capital.

Why would you want to?

Working Capital shows the financial liquidity of a company. It tells you what would be left if a company raised all of its short term assets, and used them to pay off all short term liabilities. The more working capital a company has, the less financial strain a company experiences. Working capital shows if the company has the resources necessary to expand internally or if it will have to turn to a bank and take on debt.

The formula is:

Current Assets - Current Liabilities = Working Capital

If we use the Balance Sheet Example from Friday:

Using the example above:

Working Capital = 235 - 285 = -50

This example shows a company that is in need of some help to cover working capital needs ASAP.

What if a company didn’t use the balance sheet or only looked at a balance sheet once or twice a year? Would it be too late before you figured out that you were about to have a cash crisis? I’ve heard CPA’s say that balance sheets shouldn’t be forecasted or that balance sheets just happen.  Don’t laugh, there are a lot of finance folks out there that think forecasting an income statement is enough … some think a quarterly forecast of an income statement is enough.

Instead, I subscribe to Caruso’s Predicting Cash Flows: The Foundation of an Exceptional Company theory.

I feel so strongly about this point that I make it a centerpiece of every company I am involved with. We will be better at predicting cash flows than any company out there, whether in our industry or not. We will do this not just to be better than our competitors, as this is too low a bar in my mind. Our goal is to earn exceptional returns for our investors. Knowing everything we can know about our future cash flows is the foundation for doing this.