Working Capital, Liquidity & Profitability Metrics for Business

Working Capital (Capital de Trabajo)

Working capital is the set of resources a company needs to finance the period between when payments are made to suppliers and when collections are received from customers. The shorter that period, the lower the required working capital. It is also referred to as net working capital, current capital, or capital de trabajo.

Working capital is the difference between current assets (activos corrientes) and current liabilities (pasivos corrientes). Working capital has a double meaning:

• Current assets necessary to sustain business activity — the resources required to operate the company continuously.
• Permanent resources available for stability — the amount of long-term or permanent resources the company has available to maintain its operations and achieve stability.

Working capital that must be financed with long-term resources indicates that part of the company's short-term needs are covered by permanent financing. Working capital can be categorized as follows:

Types of Working Capital

Positive Working Capital

A positive working capital provides an operating margin for the company because current assets can pay all required short-term liabilities and still leave a margin. In general, the operating fund should be positive and represent the portion of permanent resources that finance current assets.

For there to be a balance between assets and liabilities, the following must be met:

"The long-term financial resources should finance the long-term investment fund and part of the current assets."

"Short-term financial resources should finance part of the short-term investments."

Negative Working Capital

Working capital must be sufficient to ensure short-term business continuity and the stability of the financial structure. A negative working capital means that part of the long-term investments required are being financed with short-term resources, which can cause the company to have problems when paying obligations.

Depending on the inventory policy and the nature of the business, working capital may be small or negative.

Liquidity and Solvency

Liquidity is the company's ability to convert its investments into fully liquid means of payment. Liquidity shows whether it is possible to meet debt payments diligently.

Solvency is the company's ability to pay its debts while preserving the guarantees provided by its investments.

Analysis of Profitability

Economic Performance (Re = EBIT / Assets)

Economic performance refers to the return on assets. It is commonly measured as the ratio of earnings before interest and taxes (EBIT) to total assets:

Re = EBIT / Assets

The profitability of the company can be increased by:

• Increasing the margin (for example, increasing selling price while unit costs remain constant).
• Increasing turnover (increasing sales at a rate greater than the growth of assets).

Return on Equity (Rf = Net Profit / Net Worth)

Return on equity measures the relationship between net profit and the company's equity (net worth):

Rf = Net Profit / Net Worth

Financial profitability (return on equity) can be increased by raising margin, increasing turnover, or increasing leverage.

Leverage and Debt

Leverage is the relationship between total assets and equity: it indicates how much investment in the company exists for each dollar of owners' resources. Debt can improve financial profitability provided that the economic return is greater than the cost of external financing.

Note: Terms in Spanish from the original text have been preserved in parentheses to retain the original terminology: activos corrientes, pasivos corrientes, and capital de trabajo.