How is working capital defined?

• A. Current assets minus current liabilities
• B. Total assets minus total liabilities
• C. Cash plus accounts receivable minus accounts payable
• D. Net income minus taxes

Answer: (A)

Working capital measures a company’s ability to cover short-term obligations with its short-term assets. It is defined as current assets minus current liabilities. This matters because current assets—cash, accounts receivable, inventories, and other assets expected to be converted to cash within a year—tunnel through the day-to-day operations, while current liabilities—obligations due within a year such as payables and short-term debt—represent the immediate obligations the business must meet. Subtracting current liabilities from current assets gives a net amount that indicates liquidity and how much cushion the company has to fund its operations.

Why this definition fits best: it captures the liquidity available for ongoing needs rather than the overall size of the business or profitability. Other formulations miss essential pieces: total assets minus total liabilities reflects net asset value, not short-term liquidity. Focusing only on cash and receivables excludes other current assets and may misstate the true ability to meet near-term obligations. Net income minus taxes is a profitability measure, not a liquidity metric.