Which statement best describes working capital?

Which statement best describes working capital?

• A. It represents long-term solvency.
• B. It equals current assets minus current liabilities and measures short-term liquidity.
• C. It indicates market value of the firm.
• D. It equals total assets minus total liabilities.

Answer: (B)

Working capital is a measure of a company's ability to meet its short-term obligations. It is computed as current assets minus current liabilities, capturing liquidity in the near term. Current assets include items like cash, accounts receivable, and inventory that can be converted to cash within a year, while current liabilities are obligations due within a year, such as accounts payable and short-term debt. A positive result shows the firm has resources to cover upcoming bills and fund day-to-day operations, signaling good short-term financial health. In contrast, long-term solvency looks at the ability to meet obligations beyond a year, market value reflects the firm’s market price, and total assets minus total liabilities equals owners’ equity, not working capital. So the statement describing current assets minus current liabilities as a measure of short-term liquidity is the best description.

Working capital is a measure of a company's ability to meet its short-term obligations. It is computed as current assets minus current liabilities, capturing liquidity in the near term. Current assets include items like cash, accounts receivable, and inventory that can be converted to cash within a year, while current liabilities are obligations due within a year, such as accounts payable and short-term debt. A positive result shows the firm has resources to cover upcoming bills and fund day-to-day operations, signaling good short-term financial health. In contrast, long-term solvency looks at the ability to meet obligations beyond a year, market value reflects the firm’s market price, and total assets minus total liabilities equals owners’ equity, not working capital. So the statement describing current assets minus current liabilities as a measure of short-term liquidity is the best description.