How to assess the working capital efficiency of a company?

Working capital is like the Swiss Army knife for a business - a trusted tool to ensure businesses run smoothly daily. Need to pay suppliers? Check. Need to cover unexpected expenses? Check. Need to fund operations? Check. In fact, if working capital were a religion, businesses would swear by it. Which is why assessing a company's working capital efficiency is important, as it reveals more about a business than it hides. So, let's look at the important ratios that can help investors understand how a company is utilising its working capital. Current ratio This classic and the most basic ratio measures whether the company has enough resources to cover short-term obligations. It is calculated by dividing current assets by current liabilities. (Current assets can be converted into cash within a year or an operating cycle; current liabilities are a business's obligations due within a year.) A ratio of two or more is typically ideal, meaning current assets should be at least double the current liabilities. However, this ratio has its limitations; it doesn't reveal the true nature of current assets. Current assets can be of two types: cash or trade receivables. Cash is good because it is readily available, but receivables are not. Inventory turnover This r

This article was originally published on April 29, 2024.