Working Capital Explained

Without working capital, companies would never get anything done. It's the financial fuel that keeps corporations chugging along. To calculate working capital, you simply subtract current liabilities from current assets.

Companies need working capital -- they generally need to have more current assets than current liabilities. They can spend this excess capital to fund growth. It can pay for hiring new employees, building new plants, research and development of new products, additional advertising, and much more.

Here's the simple formula to determine working capital:

Working Capital = Current Assets - Current Liabilities

When evaluating a company, look for positive working capital, as that represents discretionary spending money. As with other measures, though, know that a company with gobs of working capital isn't necessarily going to win its race. Some companies simply have a lot of cash on their books -- almost perpetually. It means they have the flexibility to do all kinds of things, but if they never use it very much, then the opportunity is squandered. Working capital reveals a company's possibilities, but isn't a predictor of definite success.

Here are two quick examples of how to crunch the numbers. At the end of fiscal 2002, PepsiCo (NYSE: PEP) sported $6.4 billion in current assets and $6.1 billion in current liabilities. Subtract the latter from the former and -- presto! -- you get working capital of about $300 million. In contrast, Coca-Cola's (NYSE: KO) working capital at the same period was just $11 million, roughly. Judging from these numbers alone, PepsiCo enjoyed more flexibility.

You can learn more about how the financial world works in our Fool's School. Check out our highly regarded How-To Guides and stock newsletters, too. They can help you learn to make sense of financial statements, and find the companies with the most potential.