A contractor is developing a business plan and needs to estimate working capital requirements. Which components should be included in this calculation?
Correct Answer
B) Current assets minus current liabilities
Working capital is calculated as current assets minus current liabilities. It represents the liquid assets available to fund day-to-day operations and includes cash, accounts receivable, inventory, minus accounts payable and short-term debts.
Why This Is the Correct Answer
Working capital is a fundamental financial metric that measures a company's short-term financial health and operational efficiency. It is calculated as current assets (cash, accounts receivable, inventory, prepaid expenses) minus current liabilities (accounts payable, short-term loans, accrued expenses). This calculation shows the liquid funds available to cover day-to-day operations and unexpected expenses. For contractors, adequate working capital is crucial for purchasing materials, paying subcontractors, and covering payroll between project payments.
Why the Other Options Are Wrong
Option A: Only cash needed for daily operations
This option is too narrow and incomplete. While cash for daily operations is an important component of working capital, it ignores other critical current assets like accounts receivable and inventory, as well as current liabilities that must be subtracted from the calculation.
Option C: Equipment purchases and building costs
Equipment purchases and building costs are capital expenditures (long-term investments) rather than working capital components. These items represent fixed assets that are not easily converted to cash and are not part of the current assets minus current liabilities calculation.
Option D: Annual revenue projections
Annual revenue projections are forecasting tools used for business planning but are not components of working capital calculation. Working capital is based on actual current assets and liabilities on the balance sheet, not future revenue estimates.
Memory Technique
Think 'CA - CL = WC' (Current Assets minus Current Liabilities equals Working Capital). Remember 'current' means within one year - what you can quickly turn into cash minus what you must quickly pay out.
Reference Hint
Business and Finance for Contractors - Chapter on Financial Management and Cash Flow Analysis
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