Understanding Working Capital and Financial Stability
Working Capital: Definition and Financial Stability
Working Capital (FM) is the portion of current assets financed by equity and non-current liabilities. It is a key metric used to measure a company's financial stability. It can be calculated in two ways:
- FM = Fixed Capital - Non-current Assets
- FM = Current Assets (AC) - Current Liabilities (PC)
Working capital can be positive, negative, or zero.
Positive Working Capital
Under normal circumstances, the FM should be positive. If it is not, the company may face difficulties financing its short-term debts (Figure 1). A positive FM has the following consequences:
- It allows the company to face possible mismatches between the flow of receipts and payments.
- It permits the company to keep pace with its business activity.
- It serves to measure the company's financial situation.
- It establishes the amount of permanent capital the company must use to finance current assets to reach stability in its business operations.
- The FM should cover at least the average maturation period of the company. A higher FM better prepares the company to meet its debts.
Negative Working Capital
If the FM result is negative, it means that non-current assets are being financed with short-term debt (Figure 2). This represents an imbalance of assets where the FM cannot guarantee the financial structure or the short-term operation of the company. The company must repay more short-term money than it can generate in the short term. If this situation persists, the company may enter a state of suspension of payments.
Zero Working Capital
This is a financial situation where non-current assets are funded entirely by permanent capital, and current assets are financed entirely by current liabilities (Figure 3). In the long run, this may lead to a state of patrimonial imbalance, as some assets may not be realized within the agreed timeframe or others may fail to complete the maturation cycle.
Conclusion: Financial prudence and equilibrium imply that permanent assets should be financed such that the FM remains positive.