WORKING CAPITAL–EXPLANATIONS AND CALCULATIONS

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Working capital is the capital of a business that is used in the day-to-day operations of the business.

Alternatively, working capital can also refer to a financial ratio used to measure the operating liquidity available to a business organization.

Working capital is the lifeblood of every organization because it is what allows the organization to fulfil its day-to-day expenses.

Working capital can be calculated as current assets less current liabilities. That is,

Working capital=current assets – current liabilities.

If working capital is negative, then, there is a working capital deficiency or deficit working capital.

Components of working capital

Current assets

These are economic resources owned by a business that is expected to be completely utilized within 12 months after the reporting period.

Current assets include prepaid expenses, cash in hand, cash at the bank, inventories, trade receivables, note receivable, income receivable and bill receivables.

Current assets are expected to be converted into cash or cash equivalent within the next 12 months.

Current liabilities

These are short term debts or obligations that are expected to be repaid within 12 months after reporting.

Current liabilities include trade payable, accrued expenses, unearned revenues, note payable and bills payable.

Questions On Working Capital

Question 1

Calculate the working capital of a company with N100,000 in current assets and N60,000 in current liabilities

Solution:

The working capital is the difference between current assets and current liabilities.

Hence,

Working capital=100,000-60,000=N40,000

Question 2

Joe limited has the following information

cash in handN200000
cash in bankN200000
computer equipmentN100000
inventoryN20000
trade payablesN20000
overdraftN1000

Calculate the working capital of Joe limited

Solution:

Current assets=200,000+200,000+20,000=N420,000

Note: computer equipment is a non-current asset

Current liabilities=20,000+1000=N21,000

Working capital=420,000-21,000=N399,000

Question 3

How will the total amount of a company's working capital change when an N50,000 trade receivable is collected

Solution:

The effect of the aforementioned transaction is that the working capital remains unchanged.

The explanation for this is that trade receivables (a current asset) fell by N50,000 but cash (also a current asset) rose by N50,000.

Working capital would be unaffected because the fall in trade receivables is offset by an equal rise in cash.

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