Question

Explain why working capital is required.

Indicate two possible ratios measuring working capital and outline what does it mean if their outcome is positive

Answer 1

Working capital is required for day to day operations of the company and working capital will be helpful in ensuring that company is able to continue its operation and it will have sufficient fund to satisfy both the the operational expenses and short term liability.

Working capital is the difference of of current assets and current liabilities and it will be reflecting the liquidity in the hands of the company and it will help in meeting with short-term needs so it is a measure of the ability of the company to pay the short term expense for debt and it will help in maintaining competitive advantage.

Two type of ratios which are measuring working capital are as follows-

A. Current ratios=(current asset / current liabilities)

B. Quick ratios= (Quick asset/ current liabilities)

When there will be positive working capital, it will mean that company is having adequate current assets in its hands and enough liability in its hands to fulfill the repayment needs and carry out the the operational expenditure so the company will be having surplus cash in the short-term which will help the company to increase the liquidity and it will be helping in maintaining the competitive edge.