first what is working capital
technically it is given by a company’s current assets – its current liabilities
the less formal and more intuitive definition will intend in this course is
that working capital is given by trade receivables plus inventory plus
operating cash minus trade payables sometimes operating cash isn’t
considered when calculating working capital but consulting firms like
McKinsey believe operating cash should be a part of working capital according
to them operating cash amounts to 2% of a company’s annual revenues if a firm
has a lower amount of cash on its balance sheet we will consider its
entire cash balance as operating cash if the cash on its balance sheet is higher
then according to this methodology we should calculate 2% of revenues which
will be our operating cash the difference is defined as excess cash
money the company keeps on its balance sheet which can be invested elsewhere
and is not used for the current needs of the business ok good why does a company
need sufficient working capital well working capital can be easily compared
to a person’s cost of living we all expect payments of salary or of some
other sort which resembles receivables and we all have to make payments for
utilities and other bills which resembles payables and we keep some food
at home like inventory and some cash in our pockets and bank accounts if the
monthly payments we receive are delayed and we can’t pay our bills what will
happen the electricity company will shut off our electricity we won’t be able to
buy food from stores after we eat the food we have at home and so on the
situation is similar when we talk about companies a business uses working
capital in its daily operations this is the fuel required to run the daily
weekly and monthly operations of a Bini if we don’t have sufficient working
capital we risk being unable to run our business current liabilities could
surpass current assets and create major liquidity problems that can be solved
through some very expensive sell offs of assets or external financing which is
very costly working capital is a very important topic in our next lesson we’ll
talk about what happens when a company’s working capital is too high and what
happens if it’s working capital is too low this will do for now thanks for
watching