Working capital is defined as which of the following?

Working capital is defined as which of the following?

• A. current assets minus current liabilities
• B. total assets minus total liabilities
• C. current assets plus current liabilities
• D. equity minus assets

Answer: (A)

Working capital measures liquidity—the ability to cover short-term obligations with assets that can be converted to cash soon. It is calculated by subtracting current liabilities from current assets. Current assets are items like cash, accounts receivable, and inventory; current liabilities are obligations due within a year, such as accounts payable and short-term debt. For example, if current assets are 50,000 and current liabilities are 30,000, working capital is 20,000, meaning there are 20,000 available to meet near-term needs. The other ways of framing the numbers don’t reflect this short-term liquidity concept. Total assets minus total liabilities gives the owner’s equity, a longer-term measure of financial position, not immediate liquidity. Adding current assets and current liabilities mixes assets and obligations and doesn’t indicate net available resources. Equity minus assets equals negative liabilities, which also isn’t working capital.

Working capital measures liquidity—the ability to cover short-term obligations with assets that can be converted to cash soon. It is calculated by subtracting current liabilities from current assets. Current assets are items like cash, accounts receivable, and inventory; current liabilities are obligations due within a year, such as accounts payable and short-term debt. For example, if current assets are 50,000 and current liabilities are 30,000, working capital is 20,000, meaning there are 20,000 available to meet near-term needs.

The other ways of framing the numbers don’t reflect this short-term liquidity concept. Total assets minus total liabilities gives the owner’s equity, a longer-term measure of financial position, not immediate liquidity. Adding current assets and current liabilities mixes assets and obligations and doesn’t indicate net available resources. Equity minus assets equals negative liabilities, which also isn’t working capital.