Question

What is working capital? How does working capital relate to the operating cycle?

Short answer

The capital employed by the business entity in the daily functions of the business entity is known as working capital.

Working capital determines the ability of the company to fulfill the funding requirement of the operating cycle.

Step-by-step solution

Definition of Prepaid Expenses

The expenses that the business entity has not received as services yet, but the payment has been made are prepaid expenses. These are considered current assets and services from these expenses expected to be obtained in one year or operating cycle.

Working Capital

The excess of current assets that will be available with the company after fulfilling the obligations relating to the current commitments or liabilities is considered working capital. It is calculated as:

$\mathrm{Working}\mathrm{capital}=\mathrm{Current}\mathrm{assets}-\mathrm{Current}\mathrm{liabilities}$

Relation of Working Capital with Operating Cycle

During the operating cycle of the business entity, the essential functions require a steady flow of funds for efficient working, and this constant flow of funds is fulfilled by the working capital of the business entity.