What is the formula used to calculate working capital?

The formula used to calculate working capital is specifically designed to assess a company's short-term financial health and its ability to cover its short-term liabilities with its short-term assets. The correct formula is derived from taking current assets and subtracting current liabilities.

Current assets include items like cash, accounts receivable, inventory, and other assets expected to be converted to cash within one year. Current liabilities consist of obligations the company needs to pay within the same time frame, such as accounts payable, short-term debt, and other accrued expenses.

By subtracting current liabilities from current assets, you arrive at working capital, which indicates the liquidity of a company. A positive working capital means that the company can easily cover its short-term debts with its short-term assets, which is a sign of good financial health. Conversely, negative working capital may indicate potential financial problems, as it suggests that the company may struggle to meet its short-term obligations. This concept is fundamental when evaluating a company's operational efficiency and financial stability.