Working capital enables us to measure both liquidity and efficiency of a company. Considering how it is calculated, it gives a good and imminent overview of the financial health of the company. Obviously every industry has its own sort of expected levels of working capital, but there are still indicators out there which tell a thing or two to creditors and investors.

Essentially working capital is the difference between current assets and current liabilities. You literally subtract current liabilities from current assets to see whether there are enough assets in the possession of the company to cover for all debt that needs to be satisfied to creditors in next 12 months.

In case liabilities are in excess of current assets, it is an indication that a company may run into financial difficulties as a result. We say ‘may’ because it does not necessarily mean bankrupt or serious financial difficulties, however if the company fails to get this situation under control with other means of financing or business decisions, this is an indication of imminent financial problems.

Constantly declining working capital, but yet positive is also a signal that the company may have financial problems. Although it isn’t necessarily a problem by nature, it is still something a company’s management needs to address abruptly.

However, a serious imbalance between those two in a way that assets exceed liabilities way more than would be expected, is an indication that a company isn’t being run with efficiency in mind. Increasing working capital between periods is a signal of such case. The reason for this should be obvious – a company with too much cash in hand surely should invest it into something profit making or cost decreasing, high receivable balances imply to poor collection practices etc.

However, please remember that you should compare ratios with companies in similar industries as every sector has unique characteristics when it comes to financial ratios.