- Working capital = current assets - current liabilities.
- The current ratio shows the same relationship as a ratio instead of a dollar amount.
- Positive is usually healthier, but too much can mean idle cash or slow stock.
- Collecting faster, holding less stock and paying on sensible terms all free up cash.
Definition and formula
Working capital measures short-term financial health. It compares what a business expects to turn into cash within a year with what it must pay within a year.
Working capital = current assets - current liabilities
Both figures come from the balance sheet, which is the statement listing what a business owns and owes at a point in time.
Example:
| Current assets | Amount | Current liabilities | Amount |
|---|---|---|---|
| Cash | $20,000 | Accounts payable | $35,000 |
| Accounts receivable | $30,000 | Short-term debt | $15,000 |
| Inventory | $50,000 | Accrued expenses | $10,000 |
| Total | $100,000 | Total | $60,000 |
Working capital is $100,000 - $60,000 = $40,000. The working capital calculator does the same sum for your own figures.
What counts as current assets and liabilities
"Current" means expected to be used, collected or paid within about one year.
Current assets
- Cash and balances that can be withdrawn quickly.
- Accounts receivable: money customers owe for goods or services already delivered.
- Inventory: raw materials, work in progress and finished goods held for sale.
- Short-term investments that can be sold easily.
- Prepaid expenses: costs paid in advance, such as insurance.
Current liabilities
- Accounts payable: money owed to suppliers.
- Short-term debt and the part of long-term loans due within a year.
- Accrued expenses: costs built up but not yet paid, such as wages and taxes.
- Deferred revenue: payments received for work not yet delivered.
Long-term items such as buildings, equipment and multi-year loans are left out.
The current ratio
The dollar figure is hard to compare between businesses of different sizes. The current ratio solves this by dividing instead of subtracting.
Current ratio = current assets / current liabilities
In the example, $100,000 / $60,000 = 1.67. The business has $1.67 of current assets for every $1.00 of current liabilities.
A ratio above 1 means positive working capital. A ratio below 1 means negative working capital. What counts as a healthy level varies by industry.
A stricter version, the quick ratio, leaves out inventory because stock can be slow to sell. Here that is ($20,000 + $30,000) / $60,000 = 0.83. This shows the business depends on selling inventory to cover its short-term bills.
Positive vs negative working capital
Positive working capital gives a cushion. The business can pay suppliers and staff on time, absorb a slow month and fund growth without borrowing for every order.
More is not always better. A very high figure can point to cash sitting idle, stock that is not selling or customers who pay late.
Negative working capital is often a warning sign. If bills fall due before cash comes in, the business may need a loan or new investment to stay open.
It is not always a problem, though. A business that collects from customers immediately and pays suppliers later can run with negative working capital quite safely. Many retailers and subscription businesses work this way. The pattern matters more than the single number, so look at the trend over several periods.
Growth and seasons
Working capital needs change over time. A growing business usually has to buy more stock and wait on more customer invoices before the extra sales turn into cash. Fast growth can therefore cause a cash squeeze even when the business is profitable.
Seasonal businesses see the same effect each year. Stock builds up before the busy period and cash arrives after it. Planning for these swings in advance is easier than finding funds in a hurry.
The cash conversion cycle in plain words
The cash conversion cycle measures how long cash is tied up in operations. It follows a dollar from the moment you pay a supplier to the moment a customer pays you.
It has three parts, each measured in days:
- Days inventory: how long stock sits before it is sold.
- Days receivable: how long customers take to pay after a sale.
- Days payable: how long you take to pay your suppliers.
Cash conversion cycle = days inventory + days receivable - days payable
If stock sits for 45 days, customers pay in 30 days and you pay suppliers in 35 days, the cycle is 45 + 30 - 35 = 40 days. For 40 days, the business must fund its own operations.
A shorter cycle means less cash is locked up. If customers paid in 20 days instead of 30, the cycle would fall to 30 days. For a business with sales of $2,000 a day, that 10-day change frees roughly $20,000.
Ways to improve working capital
Most improvements come from the three parts of the cycle, plus funding and margins.
- Collect faster. Send invoices promptly, set clear payment terms and follow up on late accounts.
- Hold less stock. Order closer to demand and clear slow-moving items.
- Manage payables. Use the full payment terms suppliers offer, without paying late or harming the relationship.
- Match funding to need. Use long-term finance for long-term assets so short-term cash is not drained. A business loan calculator shows what repayments would look like.
- Protect margins. Higher profit per sale brings in more cash for the same effort. The guide to margin vs markup covers pricing basics.
- Forecast cash. A simple weekly or monthly forecast shows shortfalls before they arrive.
Knowing your break-even point also helps, because it shows the sales level needed before operations start producing spare cash. You can estimate it with the break-even calculator.
Try it with your own numbers
- Working Capital CalculatorShort-term cushion and current ratio.
- Business Loan CalculatorPayment and true cost, including fees.
- Break-Even CalculatorUnits and revenue needed to cover costs.
Frequently asked questions
How do you calculate working capital?
Subtract current liabilities from current assets. Current assets include cash, money owed by customers and inventory. Current liabilities include supplier bills, short-term debt and accrued costs due within a year. For example, $100,000 of current assets and $60,000 of current liabilities gives working capital of $40,000.
What is a good current ratio?
There is no single right number. A ratio above 1 means current assets exceed current liabilities, and many businesses aim for a level comfortably above that. The right level depends on the industry, how quickly stock sells and how fast customers pay. Compare against similar businesses and your own past results.
Is negative working capital always bad?
No. It can signal trouble if a business cannot pay bills as they fall due. But some business models collect cash from customers before they pay suppliers, which naturally produces a negative figure. In those cases it can be a sign of efficiency. Look at cash flow and the trend, not just one number.
What is the difference between working capital and cash flow?
Working capital is a snapshot taken from the balance sheet at one point in time. Cash flow measures money moving in and out over a period. A business can show positive working capital while short of cash if most of it is tied up in unsold stock or unpaid customer invoices.
This guide is general education, not financial advice. Rules of thumb vary by lender, industry and country.