You may be aware of the importance of earning revenues (Also see An Overview of Contra Revenue) by selling the products or services that your company offers if you want your business to be successful. However, even though you are making sales or deals very rapidly, it does not mean that your business is in good condition. Thus, this is why you need to understand what working capital and cash flow mean to your business. You would not be able to know the amount of working capital and cash flow your business has if your books of accounts are always messy, and this is when the accounting firms in Johor Bahru come to your rescue.
An increase in the working capital of your business might be a sign of reinvestment or expansion, while a drop in the working capital may cause severe impacts to your business plans. Nevertheless, you need to know the differences between working capital and cash flow if you want to understand how the change in working capital will affect your business. To determine the possibility of your company to face difficulties in meeting its financial obligations, you need to learn the correct ways of analysing the working capital and cash flow of your business.
To calculate the working capital that you have, you should work out the difference between the current assets and current liabilities of your company. Current assets refer to the assets which you can convert to cash in a year, whereas liabilities are the liabilities that will become due within one year. As you can find these figures in your balance sheet (Also see Balance Sheet and Consolidated Balance Sheet) easily, calculating the working capital for your company is quite simple too.
Having a huge amount of working capital or an upward trend in the working capital indicates that your company will be able to cover the liabilities that will become due soon by using its current assets. If the working capital of your company has dropped, it means that there is a high possibility that your company will not be able to pay the bills that are becoming due shortly. This means that you need to make some changes to amend this problem.
On the other hand, cash flow is the sum of cash which moves into and out of business within a specific timeframe. Having a positive cash flow means that there is an increase in the amount of cash reserve of the company. This enables business owners to reinvest in their business, pay for future debts (Also see Can You Differentiate Debt and Liability?), as well as pay the company’s shareholders.
There are three sources of cash flow, which are the operating activities, investing activities, and financing activities. Note that cash flow and net profit will seldom be the same to each other as most business owners prefer selling their goods or services on credit. Hence, keep in mind not to take the sum of cash flow as the net profit of your business.
The main difference between the working capital (Also see How to Calculate Capital Expenditure?) and cash flow is that the former would provide you with a clear picture of the current financial position of your company. In contrast, the latter shows the sum of cash your business has generated in a certain period. Thus, working capital tells you the ability of your business to pay its debts in a short-term, whereas the cash flow of the company is more progressive.
Having a low working capital and a high cash flow means that your company will be able to generate enough cash if the time is sufficient. However, if your creditors demand you to pay quickly, you may face severe financial difficulties, and this may even lead to bankruptcy.