Cambridge O Level Business Studies · Syllabus 7115 · Financial Information and Decisions
Working Capital
What is Working Capital?
The finance available to a business for its day-to-day operations, calculated as current assets minus current liabilities. Current assets are cash and the resources expected to become cash within the operating cycle, such as inventory and trade receivables; current liabilities are the obligations due within the short term, such as trade payables and an overdraft. Adequate working capital allows a business to pay wages, suppliers and other short-term obligations as they fall due.
This definition is part of the Financial Information and Decisions chapter in Cambridge O Level Business Studies.
Working Capital in context
Finance asks three different questions, and this chapter answers each one with a different tool. Can the business obtain the funds it needs? That is sources of finance. Can it pay what it owes on the day the payment falls due? That is cash flow, working capital and the liquidity ratios. Is it earning an adequate return on the money tied up in it? That is profit, the income statement and the profitability ratios. Treating those three questions as one question is the single most expensive error in this section of the syllabus.
Cash flow, working capital and profit measure three different things, and confusing them is the most common error in this chapter. A cash-flow forecast tracks expected cash receipts and payments each period, carrying the closing balance forward; working capital is current assets minus current liabilities, the finance available for day-to-day operations. Profit is revenue minus total costs over a period, and it is not cash, because a credit sale creates revenue today and cash only when the customer pays. Profitability relates that profit to revenue or capital employed, so a bigger profit on much bigger capital employed can mean the business has become less profitable.