What’s working capital analysis?

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Working capital analysis is one way to assess a company’s creditworthiness. By evaluating changes in a company’s current assets or liabilities, an analyst can determine changes in the company’s working capital. This figure helps lenders determine how much financing will be required to see a business through its normal operating cycle.

Determining the amount of a company’s working capital is generally a process of subtracting its current liabilities from its assets. Working capital is the amount of assets a business has on hand to see the time after which a product is purchased and sold, but before the business has collected on the sale. The more working capital a company has, the less it needs to borrow for routine operations and the more credit risk it represents.

An important step in working capital analysis is to review changes in a company’s net worth. A simple definition of net worth is total liabilities subtracted from total assets. If the net worth figure increases, a company should have more working capital. A lower net worth means less working capital.

Since working capital analysis is based on a company’s current assets and liabilities, as opposed to total assets and liabilities, long-term debt is not considered. That means an increase in long-term debt can lead to an increase in working capital. One of the purposes of working capital analysis is to uncover such circumstances so that business owners or lenders know when an apparent increase in working capital might in fact represent an increase in liabilities that must be paid from future earnings.

Working capital may also increase as a result of non-current assets depreciating over time. This is a normal result of business operations, as plants and equipment lose value as they age. The resulting increase in working capital is not actually more cash available to the business. This information, once again, is important to lenders, as increased working capital may not indicate increased ability to repay loans.

Analyzing working capital needs is also a matter of understanding the normal business cycle of a company. Seasonal businesses, like holiday retailers, spend a lot in the late summer and early fall, but often don’t collect the resulting sales on that money spent until late fall and winter. Working capital analysis helps a business and its lender understand how well it can close that gap, how much the business can afford to pay out of its own resources, how much it will need to borrow, and how much the business is worth paying back.

Smart Assets.

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