Explain the concept of working capital and its relevance in capital budgeting.

Explain the concept of working capital and its relevance in capital budgeting.

Working capital refers to the funds that a company uses to finance its day-to-day operations and meet its short-term obligations. It is calculated by subtracting current liabilities from current assets.

In capital budgeting, working capital is relevant because it affects the cash flows of a project. When evaluating a capital budgeting project, it is important to consider the impact on working capital requirements.

Investing in a project may require an initial outlay of funds, which can tie up working capital. For example, purchasing new machinery or expanding production facilities may require additional inventory or accounts receivable. These investments can increase the company's working capital needs.

Additionally, the timing of cash flows from a project can impact working capital. If a project generates cash inflows earlier than the associated cash outflows, it can improve the company's working capital position. On the other hand, if cash outflows occur before cash inflows, it can strain the company's working capital.

Therefore, when making capital budgeting decisions, it is crucial to consider the impact on working capital requirements and ensure that the project's cash flows align with the company's working capital position.