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Working capital is the money a business has available to pay for day-to-day financial obligations, such as salaries, rent, and office utilities. Working capital could be critical to helping keep business running, especially as operating costs change and new expenses emerge.
That’s why calculating working capital may be essential. By tracking your assets and developing a working capital plan, you may be able to better understand your business’s finances, manage cash flow, and help prepare for long-term growth.
Learn how to calculate working capital with common formulas and understand your working capital ratio to help inform financial decision-making.
Key takeaways:
- Working capital is the money a company has on hand to cover day-to-day expenses and help keep the business running.
- The standard working capital calculation is: Working capital = current assets - current liabilities.
- Positive working capital means your business may have enough cash to cover short-term expenses. Negative working capital means your business may struggle to meet short-term financial obligations.
How to Calculate Working Capital
The working capital calculation subtracts your business's current liabilities (what your business owes) from its current assets (what your business owns) to measure available funds for operations and growth.
You may find your assets and liabilities listed on your business's balance sheet.
Working Capital Formula
The standard working capital formula is:
Working capital = current assets - current liabilities
For example, if a company's balance sheet lists $300,000 in total current assets and $200,000 in total current liabilities, the business's working capital is $100,000:
Working capital = $300,000 - $200,000
Working capital = $100,000
The net working capital (NWC) formula is commonly used interchangeably with the standard working capital formula. However, to gain a clearer picture of a company's short-term solvency, some businesses may use an NWC formula that excludes cash assets and debt liabilities:
Net working capital = current assets (minus cash) - current liabilities (minus debt)
For example, a business might use the NWC formula to gauge immediate financial health in anticipation of a merger or acquisition.
Let's take a closer look at what each element of the working capital formula entails, and how to identify them for your business.
Current Assets
Current assets include any resources owned by your business that may be converted into cash within 12 months, such as:
- Cash-at-bank
- Cash equivalents (e.g. investments that may be quickly converted into cash, like government bonds)
- Accounts receivable (e.g. outstanding invoices)
- Stock (e.g. raw materials, work-in-process, finished goods)
- Short-term investments
- Prepaid expenses
Current Liabilities
Current liabilities include any bills or debts that your business must pay within 12 months, such as:
- Accounts payable (e.g. supplier payments)
- Bank overdrafts
- Sales and payroll
- Wages
- Rent
- Short-term loans
- Outstanding expenses
How to Understand Your Working Capital Calculation
It's important to understand your working capital calculation and what it means for your business.
Positive Working Capital
A positive number means you may have enough cash to cover short-term expenses and debts. As a result, your business may have extra funds to invest in new growth initiatives.
Negative Working Capital
A negative number indicates that your business may be struggling to make ends meet and cover necessary costs. You may have difficulty paying off short-term debts and allocating funds to scale your business going forward.
Zero Working Capital
A working capital calculation of zero indicates that your current assets balance out your current liabilities. While that means you’re covering your debts, it could also leave your business without a safety net to handle unexpected costs and fluctuations in cash flow.
Other Working Capital Formulas
Along with the standard and net working capital calculations, there are other working capital formulas that businesses may use to better understand their financial health:
Operating working capital = current assets - non-operating current assets
Non-cash working capital = (current assets - cash) - current liabilities
Change in working capital = working capital (current year) - working capital (previous year)
Working capital ratio = current assets / current liabilities
1. Operating Working Capital Formula
The operating working capital (OWC) formula may be useful for gauging a business's ability to fund day-to-day operations. While net working capital accounts for all assets and liabilities, operating working capital accounts for only assets and liabilities needed for core operations, such as inventory and accounts receivable. That means the formula excludes non-operating components like cash and short-term debts:
Operating working capital = current operating assets - current operating liabilities
2. Non-Cash Working Capital Formula
The non-cash working capital (NCWC) formula is used to calculate the difference between current assets — excluding cash — and current liabilities:
Non-cash working capital = (current assets - cash) - current liabilities
NCWC may help businesses understand how much of their operating capital is coming from inventory and receivables rather than liquid cash.
3. Change in Working Capital Formula
The change in working capital formula measures how much a company’s net working capital fluctuates from one accounting period to another, such as from year to year:
Change in working capital = working capital (current year) - working capital (previous year)
This formula may be used to identify trends in business cash flow and spending, and help inform financial strategies for the future.
4. Working Capital Ratio
A working capital ratio is calculated by dividing a company’s total current assets by its total current liabilities:
Working capital ratio = current assets / current liabilities
What Is a Good Working Capital Ratio?
Determining your working capital ratio may help you better understand your company’s financial health and scale your business for success.
Here's a breakdown of what different working capital ratios may indicate:
- Below 1.0: Your liabilities exceed your assets. You could have trouble covering business costs.
- 1.0–2.0: You may have the assets available to comfortably cover short-term costs and financial obligations.
- Above 2.0: You have more than twice the amount of assets needed to cover your short-term costs. You may be in strong financial standing. You may also be missing opportunities to better invest your assets or manage inventory.
The working capital ratio may be particularly useful when comparing companies’ financial standings. While two companies may have the same amount of working capital, their ratios may be quite different. For example: Company A has current assets of $1 million and liabilities of $500,000. Company B has current assets of $5 million and liabilities of $4.5 million. Both companies have $500,000 in working capital, but Company A has a ratio of 2, whereas Company B has a ratio of 1.1.
While a working capital ratio of 1.0–2.0 could be considered ideal, there's no one-size-fits-all ratio for businesses across industries. For example, retailers may operate with a lower ratio because of quick inventory turnover. Meanwhile, manufacturing companies may operate with a higher ratio because of lengthy production timelines.
Importance of Using the Working Capital Formula
Using the working capital formula may help businesses assess their liquidity and determine financial stability. This way, they may better understand their ability to meet day-to-day financial obligations and cover upcoming expenses. Working capital may also be an indicator of financial health for potential business partners, loans, and major transitions like mergers and acquisitions.
Calculating working capital may also help open up opportunities for growth and efficiency. For instance, businesses might realize they have excess capital that they could use to make investments. Or, when working capital is low, they could develop strategies to help improve cash flow, like shortening vendor payment cycles.
How to Calculate Your Working Capital Requirement
Once you calculate your current working capital, it may be helpful to know how long it takes to access that money — so you may use it to cover upcoming expenses and prepare for seasonal fluctuations.
This period of time is known as your working capital cycle: how many days it takes to convert your assets and liabilities into cash. Calculating this cycle may be an important part of managing your working capital and scaling your business with efficiency.
Learn more about how to calculate and reduce your working capital cycle.
Photo: Getty Images
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