What is Working Capital?
Working Capital is the difference between a company’s current assets and current liabilities.
The numbers need to calculate a company’s Working Capital are found on the company’s most recent balance sheet statement, located in the company’s 10-Q or 10-K financial report.
Example below from Intel’s (INTC) 2012 2nd quarter earnings.
(Click to Enlarge)
Using Intel’s numbers from above, we can determine Intel’s Working Capital:
$25,421,000,000 – $11,941,000,000 = $13,480,000,000
Working capital gives investors a specific number compared to a ratio like the current ratio does. Working capital is used to determine two things; First, a company’s short term financial health by seeing if its current assets are enough to cover its current liabilities. A positive number indicates that a company should be able to meet its short term liabilities.
We can see above that Intel’s $25 billion in current assets is more than enough to cover its $11.9 billion in current liabilities.
A steady increase in working capital can also be an indication of increased inefficiencies of the company selling and receiving payments for its products. If a company’s accounts receivables or inventories are increasing significantly, it may be a sign that they company is not collecting money as fast as they could be or selling product. This leads to the company potentially taking on additional short term loans to cover expenses until the company collects payment.
However also note that an increase in working capital could also be due to an increase in cash or cash equivalents, which don’t necessarily indicate these inefficiencies.
As a side note: Working Capital is one of Warren Buffett’s favorite fundamental checks to evaluate a company’s investment potential.
Buffett may have been taught to closely examine working capital by his mentor, Ben Graham, who devotes a chapter in his book “The Interpretations of Financial Statements” to working capital:
Interpretation of Financial Statements, Defines this as:
“Working capital is the net current assets. Found by deducting current liabilities from the current assets.
Working capital is a consideration of major importance in determining the financial strength of an industrial enterprise, and it deserves attention also in the analysis of public utility and railroad securities, especially where there are large short-term borrowings. In the working capital is found the measure of the company’s ability to carry on its normal business comfortably and without financial stringency, to expand its operations without the need of new financing, and to meet emergencies and losses without disaster.
The proper amount of working capital will vary with the volume of sales and the type of business. The chief point of comparison is the amount of working capital per dollar of sales.
He working capital available for each share of common stock is an interesting figure in common stock analysis especially when this figure (after deducting all prior securities) exceeds the market price of the comment. The growth or decline of the working capital position over a period of years is also worthy of the investors attention”
Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports, Defines this as:
“The company’s working capital is the amount of money left over after you subtract current liabilities from current assets.
Working capital is the amount of money the enterprise has to “work with” in the short term. Working capital feeds the operations of the enterprise with dollar bills. Working capital is also called “net current assets” quote or simply “funds”. “
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