What Working Capital Is and Why It Is Important for A Business

What is working capital? 

According to the principles of accounting (https://www.principlesofaccounting.com/chapter-4/), is represented as " Current assets - Current liabilities ". Notice that the "current" reflects you can transfer it into cash in a short period, and also means the obligations you have to repay in a short period. So the remain after current assets minus current liabilities means how much quick assets or highly liquid assets you have on your hand to run the business in a particular period. 

Why it is important for a business?

The working capital reflects your abilities to fuel business activities and operating. Suppose you have $1,000 in cash, $5,000,000 worth of real estate, and receive a regular paycheck of $3,000 every month on 28th. Here is the situation, you have an obligation to pay $5,000 on February 25, you only have $1,000 cash on hand, the real estate might take 2-3 years to sell, your paycheck must wait until February 28. What would you do? It's similar to the situations while we are running a business. 

As an example, describe a business that operates where you live and describe how knowing what the working capital of that company would be useful to the business leaders of that company and to outside investors.

My father owns a food company in Taiwan where I live. To run the business, he has to track the pork inventory and purchasing when it's less than the minimization. The pork needs to be stored in a large fridge and costing electricity, and the payroll is also the cost of operating. The working capital is needed to pay the electricity bill, the pork inventory, and the payroll, in order to keep the business running and growing. The electricity bill, the pork inventory, and the payroll are near-term obligations, the current liabilities, all be billed every short period and must be paid in time. On the other hand, the receivables and cash are the two accounts which most likely be used to pay those near-term obligations. Obviously, if he does not have enough cash or other current assets on hand to pay those bills, his financial stress will increase. 

The food company is being organized as a sole proprietorship and run by my father, so it may not has any outside investors. But if we imagine that it is a corporation and has issued common stocks, the working capital could be a cause to lower its value on shares. New investors will analyze the working capital to evaluate the company's ability to deal with financial stresses since it's important to their investment.

References

Walther, L. M. (2012). Principles of accounting. Logan, UT: Utah State University. Retrieved from https://www.principlesofaccounting.com/chapter-4/