How does working capital affect a company's liquidity?

Working capital directly affects a company's liquidity by determining its ability to meet short-term obligations.

Working capital, which is the difference between a company's current assets and current liabilities, is a key measure of a company's short-term financial health and operational efficiency. It provides a clear picture of a company's ability to pay off its short-term liabilities with its short-term assets. Therefore, the more working capital a company has, the more liquid it is considered to be.

If a company has positive working capital, it means that it has more current assets than current liabilities. This indicates that the company has enough resources to cover its short-term debts, which in turn enhances its liquidity. It suggests that the company can easily convert its assets into cash without facing any financial distress or having to take on additional debt. This is crucial for the smooth operation of the business as it ensures that the company can meet its operational expenses and short-term debts as they fall due.

On the other hand, if a company has negative working capital, it means that its current liabilities exceed its current assets. This is a sign of potential liquidity problems as the company may struggle to pay off its short-term debts. It may have to sell off long-term assets, take on additional debt or even face bankruptcy if it cannot generate enough cash quickly.

In summary, working capital plays a vital role in maintaining a company's liquidity. It is a key indicator of a company's financial health and operational efficiency. A company with sufficient working capital can meet its short-term obligations, invest in its operations, and withstand financial shocks, thereby ensuring its long-term sustainability.