requires additional funding-working capital-of $10. This suggests that current liabilities are insufficient to fund the total value of current assets, so Pear Inc. In the figure below Pear Inc.’s current assets are greater than its current liabilities, so it has net current assets of $10 ($50 – $40).Īdapted from the Colour Accounting Learning System by Wealthvox. This is a dubious notion, which we’ll come back to, but for the moment let’s assume that to be the case. There is an implication that current liabilities are a source of funding for current assets. This is different to the principles that some creditors have security over assets or that in a winding-up some creditors take precedence over others and that all creditors take precedence over shareholders. Working capital rests on the notion that different sources of funding are allocated to specific types of assets in a specific order. Working capital refers to non-current obligations Ī functional explanation will make this clear but let’s first look at the traditional way of determining working capital-calculating net current assets. Working capital originates from a calculation used by bankers to indicate how much of their long-term lending is being used to fund current assets. In classes, my students are required to consider the origins of working capital and then I give them an alternative method of calculation. And we haven’t even started on ‘natural’, ‘social’, ‘human’, ‘manufactured’, ‘intellectual’, or ‘emotional’ capitals. Oh, and in one case it means the acquisition of non-current assets.Īsk a banker or an economist and a slew of additional possibilities will open up. Not nuanced quibbles over interpretation, but big whacking differences.ĭepending on context, capital variously refers to one part of equity, all of equity, all of equity and liabilities, just liabilities, just non-current liabilities, just financial liabilities, or some combination of those. ‘Capital expenditure’, ’share capital’, ‘return on capital’ and ‘working capital’ are common accounting terms but each has a different meaning. “Capital” is ambiguous and slippery-if you hear someone say capital be sure to find out what they mean before making assumptions.
“Working” isn’t helpful-we don’t have non-working capital, but working capital suggests that it works and the rest of capital doesn’t. The problem starts, as it usually does, with language. To teach it well, the term needs careful scrutiny. Working capital is a widely used but often misunderstood term.
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