Working capital is defined as current assets minus current liabilities. Current assets are assets that will be used within the year, and current liabilities are debts that will be paid off within the year. By itself, the difference between current assets and current liabilities provides little information, however, when compared against other companies as a percentage of sales, the ratio becomes more relevant and useful.
Current Resources
Working capital is composed of current resources. It is the way analysts measure a company's ability to cover its most current needs in terms of funding and inventory. Common current assets include inventory, accounts receivable, cash and marketable securities. Common current liabilities include accounts payable and other short-term debts.
Working Capital
Negative working capital is not always a bad thing. It means that current liabilities are more than current assets. Oftentimes current liabilities do not charge a rate of interest. That is, accounts payable represents inventory that has not been paid for with cash. These are credit sales, not traditional loans, and usually do not charge a rate of interest. As a result, accounts payable may represent a form of short-term financing, which is considered good business.
Percent of Sales
Percent of sales is a forecasting tool used by financing and investment analysts who want to compare companies in the same industry against one another. Sales are one of the most commonly used measures of business performance, and comparing the value of any business line item against sales provides a relevant basis of comparison against other companies.
Interpretation
Working capital as a percent of sales is calculated by dividing working capital by sales. In general, the higher the number, the more financial risk is involved in company operations, as it takes a higher degree of assets to run short-term operations. Compare the ratio against other companies in the same industry for additional insights.
