Based on the formula of calculating working capital in section 5.1, we can identify some of the key components of working capital. These components are current assets and current liabilities. The components of working capital can be found in the company’s balance sheet.
Current assets are economic resources that the company currently holds or are expected to be earned within the next 12 months; and which can be easily turned into cash. They are short-term assets that a company is able to liquidate into cash easily within one year. Current assets are needed to run day-to-day operations and pay current expenses. Current assets are important items in a company’s balance sheet, and their value is calculated at the current market price. The types of current assets include:
- Cash and Cash Equivalents: Money that a company has at hand as well as foreign currencies, money market accounts, and cash held at bank.
- Inventory: Also known as stock; unsold goods that are being stored as they await to be sold. It includes raw materials used to produce goods, goods bought for resale, and finished goods that have not been sold.
- Accounts Receivable: Another important component of working capital is debtors; all money that customers owe the company for purchasing inventory on credit. For example, let’s say you sold books to a bookshop on credit with the agreement that they will pay full amount in 3 months. The money owed is recorded on the balance sheet as accounts receivable.
- Notes Receivable: All of the claims to cash for other agreements, often agreed to through a physically signed agreement.
- Prepaid Expenses: These are expenses that have been paid in advance. For example, when you pay rent for three months in advance, it is categorized as prepaid expense.
Current Liabilities are also key components of working capital. They are the debts that a company owes, which are payable within the next 1 year. The concept of working capital is used to establish whether a company is able to pay off such debts in full within the year. Some types of current liabilities are:
- Accounts Payable: all unpaid bills owed to third parties for raw materials, utilities, rent, and other operating expenses. This includes money owed to suppliers for the purchase of raw materials on credit.
- Wages Payable: These are unpaid wages and salaries owed to employees. They are usually money accrued for one month.
- Short Term Loans: Bank loans that last for less than 1 year are considered as current liabilities. This includes current portion of a long term debt that is payable in the next 12 months.
- Accrued Tax Payable: This refers to the obligations owed to the government in the form of tax. They include accruals for tax obligations/
- Dividend Payable: These are money owed to shareholders as accrued dividend payments.
- Unearned Revenue: All money or capital received before services or products are delivered to the customer are referred to as unearned revenue. If the company fails to deliver the service, they may be forced to pay back all the capital received in advanced.