Floating Capital
Floating capital, also known as working capital, refers to the operational liquidity of a business. It’s the difference between current assets and current liabilities.
Current assets are resources that are expected to be converted into cash, sold, or consumed during the normal operating cycle of a business, usually one year. This includes cash, accounts receivable, inventory, marketable securities, pre-paid expenses, and other short-term assets.
Current liabilities are obligations that are expected to be settled within one year. This includes accounts payable, accrued expenses, short-term debt, and other short-term liabilities.
The formula for working capital (or floating capital) is:
Working Capital = Current Assets – Current Liabilities
If current assets are greater than current liabilities, the company has positive working capital, indicating that it has enough resources to cover its short-term liabilities. If current liabilities are greater, the company has negative working capital, which could signal financial trouble.
However, too much working capital could indicate that the company isn’t investing its excess assets effectively. Like many aspects of finance, the optimal level of working capital depends on the specific circumstances of the company.
Example of Floating Capital
Let’s look at an example of calculating floating capital or working capital for a hypothetical company:
Let’s say that Company XYZ has the following current assets and current liabilities:
Current Assets:
- Cash: $50,000
- Accounts Receivable: $100,000
- Inventory: $200,000
- Marketable Securities: $50,000
- Prepaid Expenses: $20,000
Total Current Assets = $420,000
Current Liabilities:
- Accounts Payable: $100,000
- Accrued Expenses: $50,000
- Short-term Debt: $70,000
- Other Current Liabilities: $30,000
Total Current Liabilities = $250,000
To calculate the floating capital (or working capital), subtract the total current liabilities from the total current assets
Working Capital = Current Assets – Current Liabilities
Working Capital = $420,000 – $250,000
Working Capital = $170,000
So, Company XYZ has a positive working capital of $170,000. This means that after paying off its short-term obligations, it will still have $170,000 worth of resources that it can use to run its day-to-day operations or invest in its future growth.
