(^174) Financial Management
is often recommended in order to ensure that a firm will be able to pay bills. The GHI
Company has $1,100 of net working capital ($2,700-$1,600) which will most likely be
sufficient to cover al its bills. Its current ratio of 1.69 ($2,700/$1,600), should provide
sufficient liquidity as long as its accounts receivable and inventories are relatively
liquid.
An alternate definition of net working capital
An alternate definition of net working capital is that portion of a firmís current assets
financed with long-term funds. This definition can best be illustrated by a special type
of balance sheet, like that for the GHI Company presented in Figure 5. The vertical
axis of the balance sheet is a dollar scale on which all the major items on the firmís
balance sheet are indicated.
Figure 5: A special balance sheet for the GHI Company
Figure 5 shows that the firm has current assets of $2,700, fixed assets of 4,300 and
total assets of $7,000. It is also shows that the firm has current liabilities of $1,600, long-
term debts of $2,400 ($4,000-$1,600), and stockholdersí equity of $3,000 ($7,000-
$4,000). A firmís long-term debt plus its stockholdersí equity represents its sources of
long-term funds; the GHI Companyís long-term funds equal $5,400. The portion of the
firmíí current assets that was financed with long-term funds has been labeled ìnet
working capitalî in Figure 5. Analysis of this figure should enable the reader to better
understand why a firmís net working capital can be thought of as the portion of current
assets financed with long-term funds. Since current exceed current liabilities the amount
of the excess must be financed with longer-term funds. The usefulness of this alternate
definition will become more apparent in a later section of the chapter.
6,000
5,000
4,000
3,000
2,700
2,000
1,600
1,000
Net Working Capital
Current Assets
Assets Liabilities and Equities
Total Assets LiabilitiesTotal
& Equities
Long Term Debt
7,000
Long Term Funds
Current Liabilities
frankie
(Frankie)
#1