Can Changes in Working Capital Can Affect a Company’s Cash Flow?
To know the current status of a company it is important to know its true earning power. Business appraisals can be conducted by measuring cash flow. In this article, you will be learning how changes in working capital can affect a company’s cash flow.
What is Working Capital?
Working capital is the representation of a company’s current assets and current liabilities. When a working capital of a certain firm is changed, it can impact the firm’s cash flow statement.
The operating cash flow (OCF) portion of the cash flow statement describes the detailed changes in the shorter-term working capital needs of a business. When a business has a positive working capital figure, it means that the current assets are greater than the current liabilities. On the other hand, a negative working capital means that the firm has disbursed more cash than it has acquired.
Why is Working Capital Important to Know?
A working capital can represent the overall health of a certain business. Since it is a core part of a company’s daily operations, knowing the working capital can help you discover if a certain company has an underlying financial problem. It is a red flag if a working capital of a firm persists to be negative for quite some time.
If there is an increase in a company’s working capital, it can mean that the management has invested its resources wisely, and if a company has a negative change in its working capital, it means that the management has only relied with short-term borrowing to fund its operations.
When Do You Use Working Capital Data?
Usually, working capital data are significant if you are trying to review cash flow fluctuations to see if there is something anomalous going on. Another is when during earnings forecast so that investors can perform valuation methods to see if the business is worth investing to.
When a company has low working capital, it means that the business is just barely getting through and has little capital to cover its short-term costs. In doing valuation, you have to consider a business with a solid operating model which knows exactly the amount of money it needs for it to run its business smoothly and the excess can be invested to a number of growth projects to help it increase its business value.
However, a company may increase its present liabilities and decrease its working capital if it decides to take on new projects and expand its operations. In such case, it is important to note that the company is highly focusing on growth and is just trying to maintain enough liquidity to sustain is present commitments and obligations.
Working capital can vary from business to business. As an end-user of data, you can note patterns of increasing or decreasing figures for you to compare it to similar businesses of the same industry. It can help you ensure that you are making an accurate analysis of a company’s operational efficiency.
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