Which equation defines working capital, and what does it indicate?

Which equation defines working capital, and what does it indicate?

• A. Working capital = Current Assets − Current Liabilities; measures short-term liquidity.
• B. Working capital = Net Income − Expenses; measures profitability.
• C. Working capital = Total Assets − Total Liabilities; measures solvency.
• D. Working capital = Current Liabilities − Current Assets; measures liquidity risk.

Answer: (A)

Working capital measures a company’s ability to cover its short-term obligations with its short-term resources. It is calculated by subtracting current liabilities from current assets, which shows how much cushion is available to run daily operations. This equation correctly defines working capital and indicates short-term liquidity—the higher the positive balance, the better the liquidity; a negative balance signals potential liquidity risk. The other options mix different concepts: net income and expenses relate to profitability, not liquidity; total assets minus total liabilities equals owners’ equity, not working capital; and reversing the order (current liabilities minus current assets) would imply the opposite sign and misinterpret liquidity.

Working capital measures a company’s ability to cover its short-term obligations with its short-term resources. It is calculated by subtracting current liabilities from current assets, which shows how much cushion is available to run daily operations. This equation correctly defines working capital and indicates short-term liquidity—the higher the positive balance, the better the liquidity; a negative balance signals potential liquidity risk. The other options mix different concepts: net income and expenses relate to profitability, not liquidity; total assets minus total liabilities equals owners’ equity, not working capital; and reversing the order (current liabilities minus current assets) would imply the opposite sign and misinterpret liquidity.