Working capital management

Efficient management of working capital is extremely important to any organisation. Holding too much working capital is inefficient, holding too little is dangerous to the organisation's survival.

Working capital is the everyday term for what accountants call net current assets. The working capital figure is the total of current assets minus the total of current liabilities. The main current assets are stock, debtors and cash. The current liabilities are creditors and accrued expenses. The key factor in the word current is that they are expected to turn into cash, or be paid from cash, within twelve months.

As a general rule the organisation wants as little money tied up in working capital as possible. However, there are always trade-offs. The most obvious problem is running out of cash so you cannot pay the wages, or being unable to provide a service because you have run out of a vital resource: for example, a meals service being unable to produce the required number of meals because they did not have enough foodstuffs in stock.

In order to assess whether you have a "safe" amount of working capital there are two important calculations you can make:

The current ratio

The current ratio is the relationship between the total current assets and the total current liabilities.

Generally speaking a service organisation should have about £1.25 current assets for every £1 of current liabilities. If there are significant trading operations such as shops or mail order selling then the ratio should be closer to £2 of current assests for every £1 of current liabilities.