You can usually find this information on a company’s balance sheet, which should include a subtotal of current assets. If the balance sheet does not include a subtotal of current assets, read through the balance sheet line by line. Add up all accounts which meet the definition of a current asset to come up with a subtotal. For example, you would include the figures listed for “accounts receivable,” “inventory,” and “cash and equivalents. "
The balance sheet should include a subtotal of current liabilities. If it does not, use the balance sheet information to find this total by adding up the listed liabilities. For example, this would include “payables and provisions,” “taxation payable,” and “short term loans. "
For example, imagine a company had current assets of $50,000 and current liabilities of $24,000. This company would have working capital of $26,000. The company would be able to pay all its current liabilities out of current assets and would also have cash left over to serve other purposes. The company could use the cash for financing operations or long-term debt payment. It could also distribute the money to shareholders. If current liabilities are greater than current assets, the result is a working capital deficit. [5] X Research source A deficit could signal that the company is at risk of becoming insolvent (meaning unable to pay their debts when they become due). There are many reasons why a company may become insolvent. Such a company may need other sources of long-term financing. This may signal the company is in trouble, and may not be a good investment. For example, consider a company with current assets of $100,000 and current liabilities of $120,000. This means they will only be able to pay $100,000 of that debt, and will still owe $20,000 (their working capital deficit). In other words, the company will be unable to meet its current obligations and must sell $20,000 worth of long-term assets or find other sources of financing. If the company is in danger of being insolvent, they may opt to restructure the debt so that they can continue operating while paying off their debt.
A ratio is a way of comparing two values, relative to one another. [6] X Research source Calculating a ratio is usually a matter of simple division. To calculate the current ratio, divide current assets by current liabilities. Current ratio = current assets ÷ current liabilities. [7] X Research source Using the example from Part 1, the company’s current ratio is 50,000 ÷ 24,000 = 2. 08. This means that the company’s current assets are 2. 08 times greater than the company’s current liabilities.
The ideal current ratio is around 2. 0. A falling ratio, or a ratio below 2. 0 could mean a greater risk of insolvency. On the other hand, a ratio in excess of 2. 0 might mean that management is too conservative and reluctant to take advantage of the the company’s opportunities. [9] X Research source Using the example above, a current assets ratio of 2. 08 is probably healthy. You could interpret this to mean that current assets could fund current liabilities for a little over two years. This is assuming, of course, that liabilities stay at the current level. The acceptable current ratio will differ between industries. Some industries are capital intensive and may need to borrow to finance operations. Manufacturing companies, for example, are likely to have high current ratios.
For example, a company with too little working capital risks not being able to pay its current liabilities. Holding too much working capital though can also be a problem. A company with lots of working capital may be able to invest in long-term productivity improvements. For example, surplus working capital could be invested in new production facilities or retail stores. These types of investments can increase future revenues. If the working capital ratio is too high or low, consider the tips below for some ideas on how to improve the ratio.
