The adequacy of a company's working capital depends on the industry in which it competes, its relationship with its customers and suppliers, and more. Here are some additional factors to consider:
- The types of current assets and how quickly they can be converted to cash. If the majority of the company's current assets are cash and cash equivalents and marketable investments, a smaller amount of working capital may be sufficient. However, if the current assets include slow-moving inventory items, a greater amount of working capital will be needed.
- The nature of the company's sales and how customers pay. If a company has very consistent sales via the Internet and its customers pay with credit cards at the time they place the order, a small amount of working capital may be sufficient. On the other hand, a company in an industry where the credit terms are net 60 days and its suppliers must be paid in 30 days, the company will need a greater amount of working capital.
- The existence of an approved credit line and no borrowing. An approved credit line and no borrowing allows a company to operate comfortably with a small amount of working capital.
- How accounting principles are applied. Some companies are conservative in their accounting policies. For instance, they might have a significant credit balance in their allowance for doubtful accounts and will dispose of slow-moving inventory items. Other companies might not provide for doubtful accounts and will keep slow-moving items in inventory at their full cost.
In short, analyzing working capital should involve more than simply subtracting current liabilities from current assets.
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