Which of the following is a key component of working capital?
A. Long-term debt
B. Fixed assets
C. Accounts receivable
D. Retained earnings
The correct answer and explanation is:
Correct Answer: C. Accounts receivable
Explanation:
Working capital refers to the short-term assets and liabilities a company uses in its daily operations. It is calculated as current assets minus current liabilities. A positive working capital indicates that a company can pay off its short-term liabilities with its short-term assets, which is essential for maintaining smooth business operations.
Accounts receivable is a key component of working capital because it represents the money owed to a company by its customers for goods or services delivered but not yet paid for. It is classified as a current asset because it is expected to be converted into cash within one year. Effective management of accounts receivable ensures steady cash flow, which is vital for covering operational costs such as paying suppliers, salaries, and other short-term obligations.
On the other hand, long-term debt and fixed assets are not considered part of working capital. Long-term debt refers to obligations that are due beyond one year and are classified under long-term liabilities. Fixed assets, such as machinery and buildings, are tangible long-term resources used in production and not easily converted to cash in the short term.
Retained earnings represent the accumulated profits that a company has reinvested in the business rather than distributed to shareholders. Although important in assessing a company’s financial health, retained earnings are not part of working capital since they are not a current asset or liability.
In summary, accounts receivable plays a direct role in day-to-day financial management, making it a crucial part of working capital. Proper control of receivables improves liquidity and strengthens a company’s ability to meet short-term obligations efficiently.