Working Capital
The difference between current assets and current liabilities, measuring short-term financial health.
Definition
Working capital is calculated as current assets (cash, accounts receivable, inventory) minus current liabilities (accounts payable, short-term debt, accrued expenses). It measures your business's ability to pay short-term obligations and fund day-to-day operations.
Positive working capital means you have more short-term assets than liabilities—you can cover upcoming bills. Negative working capital can signal cash flow problems, though some business models (like retailers who collect cash before paying suppliers) operate successfully with negative working capital.
Why It Matters
Working capital is essential for business stability and growth. Without adequate working capital, you may struggle to pay suppliers on time, make payroll, or invest in opportunities. Too much working capital, however, might indicate inefficient use of resources—money sitting in receivables or inventory rather than earning returns.
Understanding your working capital cycle helps optimize cash flow. If you can reduce inventory days, collect receivables faster, or extend payables terms, you can operate with less working capital. Many businesses monitor working capital ratios (current assets ÷ current liabilities) to track liquidity over time.
Examples
- 1
A company with $200,000 in current assets and $120,000 in current liabilities has $80,000 in working capital and a healthy 1.67:1 ratio.
- 2
A growing business calculates they need 30 days of sales as working capital to cover the gap between paying suppliers and collecting from customers.
- 3
A seasonal retailer builds working capital in slow seasons to fund inventory purchases before the holiday rush.
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