Calculating the Acceptable Working Capital Level
Working capital is what mostly drives business operational cash flow. Companies have to find out the acceptable levels matching their business requirements to make sure that they maintain adequate net working capital.
Working Capital Calculation and Ratio
The former is calculated by subtracting a company’s current liabilities from assets. However, managers and accountants often use certain ratios to assess WC and help decide the best working capital level to maintain. The quick ratio is one such that excludes stock from its calculation. Old or obsolete stock gives minimal value to businesses, as they cannot sell either of these inventory at expected rates to raise funds. Generally, the stock-less working capital generating a ratio of one gives an acceptable level of WC.
Acceptable levels of it vary by company’s type, industry, operational efficiency, and stage of growth. For instance, a quickly growing organization in the same segment with revenues identical to another may have considerably higher working capital requirements. A company experiencing fast growth might have working capital requirements fluctuating considerably, and hence, it should add a cushion amount to the acceptable level of working capital. Besides, the quality of current assets impacts working capital as well. For instance, a company needing customer deposits and having strong accounts receivable collection measures will require fewer funds than another whose customers often pay up in 30 days or 60 days.