The working capital requirement is the minimum amount of resources that a company requires to effectively cover the usual costs and expenses necessary to operate the business. Since the capital needs of each company will be a little different, there is no ideal amount of working capital that is universally applicable to all businesses, or even to companies engaged in the same industry. Even so, new companies can develop an idea of what type of requirement they will need to operate at given levels by researching the cost and expenses associated with other corporations engaged in similar operations.
The basic formula for determining working capital involves only two factors. First, it is necessary to define the current liquid assets that the company has. This may be somewhat different from general assets, since the focus is on those resources that can be converted into cash quickly and easily. Liquid assets may be such resources as the outstanding current accounts receivable balance, property that is not directly used in the operation of the business, and balances in various operating accounts.
The current liabilities of the corporation must also be determined. This includes both short-term liabilities, such as the usual and general monthly operating expenses, as well as any long-term debt. By deducting the liabilities from the liquid assets, it is possible to determine the current working capital requirement.
The general idea is to ensure there is enough revenue generated to cover the essential operations of the corporation and allow for additional revenue to be generated in the future. Companies may operate with a negative working capital, based on some long-term debt, and this is not necessarily a sign that the company is in financial trouble. Calculating the current working capital requirement at least once a quarter, however, will allow the company to spot trends that may indicate problems. For example, if the requirement reveals a higher negative ratio from previous periods even though long-term debt was reduced, this may indicate an issue with decreased sales, lower earnings, or other factors.