Arizona Contractors License Practice Exam

Which of the following correctly defines "working capital"?

1. The total liabilities of a company

2. The difference between current assets and current liabilities

3. The sum of cash assets held by a business

4. The total investments made by owners

The correct answer is: The difference between current assets and current liabilities

The correct definition of "working capital" is the difference between current assets and current liabilities. This measure provides insight into a company's short-term liquidity and operational efficiency. Specifically, current assets include cash, inventory, and accounts receivable, which are resources expected to be converted into cash or used within one year. Current liabilities consist of obligations the company needs to settle within the same period, such as accounts payable and short-term debt. By calculating working capital, a business can assess its ability to cover short-term debts and continue its operations without needing additional financing. Positive working capital indicates that a company can fund its current operations and invest in future activities, while negative working capital may signal potential financial difficulties. The other options do not capture the essence of working capital. While total liabilities represent a company's overall debt, they do not factor in the company's assets. Cash assets alone do not account for other current assets or liabilities, leading to an incomplete picture. Lastly, total investments made by owners focus on the equity aspect rather than liquidity concerns, missing the important interplay between assets and liabilities that defines working capital.