Businesses use several financial measures to determine the efficiency with which they use working capital (WC)A liquidity ratio that measures a company's solvency. It indicates if there is sufficient short-term financial assets to meet short-term obligations. The formula is Current assets – Current liabilities.. These are often referred to as liquidity measures. Managing WC involves ensuring that the business has sufficient short-term financial assets to meet short-term financial obligations.

WC is current assets minus current liabilities. Note that the long-term debt component is not included as it is a long-term liability. Expressed as a percentage of sales, the company needs WC of 15% of sales:

WC = 15% (cash) + 10% (accounts receivable) + 20% (inventory) − 30% (accounts payable)
WC = 45% − 30% = 15%

At 15% of anticipated Year 2 sales of $55,000, required WC would be 15% × $55,000, or $8,250.

(Choice A) WC of ($2,750) fails to include the 20% inventory requirement (15% cash + 10% accounts receivable − 30% accounts payable) for a ratio of −5% of sales [$55,000 × (−5%)].

(Choice B) WC of $5,500 nets inventory from accounts receivable (20% − 10%) for a WC ratio of 10% of sales ($55,000 × 10%).

(Choice C) WC of $7,500 is based on 15% of Year 1's cash requirements of $50,000.

Things to remember:
Appropriately managing working capital (WC) (ie, current assets − current liabilities) helps to ensure that businesses have sufficient short-term financial assets to meet short-term financial obligations. One method for forecasting future WC requirements is to compute WC as a percentage of future sales.