Circulating Capital
Circulating capital, also known as working capital or short-term capital, refers to the financial resources used by a business to finance its day-to-day operations and maintain its liquidity. It consists of current assets and current liabilities, which are financial resources and obligations that are expected to be converted into cash or used up within a year or one operating cycle. Circulating capital is a key indicator of a company’s short-term financial health and operational efficiency.
Current assets typically include:
- Cash and cash equivalents: Money held in checking and savings accounts, as well as highly liquid short-term investments such as treasury bills and commercial paper.
- Accounts receivable: Money owed to the company by its customers for goods or services provided on credit.
- Inventory: Raw materials, work-in-progress, and finished goods that the company holds for sale in the ordinary course of business.
- Short-term investments: Marketable securities or other investments that can be easily converted into cash within a short period.
Current liabilities typically include:
- Accounts payable: Money the company owes to its suppliers for goods or services purchased on credit.
- Short-term debt: Loans or other borrowings that are due for repayment within a year.
- Accrued expenses: Expenses that the company has incurred but not yet paid, such as wages, taxes, and interest.
- Deferred revenue: Money received in advance for goods or services that the company has not yet provided.
Circulating capital is calculated as the difference between current assets and current liabilities:
Circulating Capital (Working Capital) = Current Assets – Current Liabilities
A positive circulating capital indicates that a company has sufficient resources to cover its short-term obligations, while a negative circulating capital may signal liquidity problems and potential financial distress. Maintaining an adequate level of circulating capital is essential for a company to meet its operational needs, invest in growth opportunities, and respond to unforeseen challenges.
Example of Circulating Capital
Let’s consider a fictional company, XYZ Manufacturing, to illustrate the concept of circulating capital. We will use simplified numbers to make the example easy to follow. Assume the following financial information for XYZ Manufacturing:
Current Assets:
- Cash and cash equivalents: $50,000
- Accounts receivable: $70,000
- Inventory: $100,000
- Short-term investments: $30,000
Current Liabilities:
- Accounts payable: $60,000
- Short-term debt: $40,000
- Accrued expenses: $20,000
- Deferred revenue: $10,000
To calculate XYZ Manufacturing’s circulating capital, we first need to find the total current assets and total current liabilities:
Total Current Assets = $50,000 (Cash) + $70,000 (Accounts receivable) + $100,000 (Inventory) + $30,000 (Short-term investments) = $250,000
Total Current Liabilities = $60,000 (Accounts payable) + $40,000 (Short-term debt) + $20,000 (Accrued expenses) + $10,000 (Deferred revenue) = $130,000
Now we can calculate circulating capital (working capital) by subtracting the total current liabilities from the total current assets:
Circulating Capital (Working Capital) = $250,000 (Total Current Assets) – $130,000 (Total Current Liabilities) = $120,000
In this example, XYZ Manufacturing has a circulating capital of $120,000, indicating that it has sufficient short-term financial resources to cover its current obligations and finance its day-to-day operations. This positive circulating capital suggests that XYZ Manufacturing is in good financial health and can effectively manage its working capital to meet its operational needs and invest in growth opportunities.
