What is Working Capital?
The capital available for day-to-day operations. A key measure of short-term liquidity and operational efficiency.
Key Takeaways
- •Working Capital = Current Assets - Current Liabilities
- •Measures ability to meet short-term obligations and fund operations
- •Growth usually requires increased working capital investment
- •Optimize by managing inventory, receivables, and payables efficiently
Working Capital Definition
Working capital (also called net working capital or NWC) is the difference between a company's current assets and current liabilities. It represents the capital available to fund day-to-day business operations.
Working Capital Formula
Current Assets (Examples)
- Cash and cash equivalents
- Accounts receivable
- Inventory
- Prepaid expenses
- Short-term investments
Current Liabilities (Examples)
- Accounts payable
- Accrued expenses
- Short-term debt
- Current portion of long-term debt
- Deferred revenue
Example Calculation
Current Assets
| Cash | $500,000 |
| Accounts Receivable | $800,000 |
| Inventory | $600,000 |
| Prepaid Expenses | $100,000 |
| Total Current Assets | $2,000,000 |
Current Liabilities
| Accounts Payable | $400,000 |
| Accrued Expenses | $200,000 |
| Short-term Debt | $150,000 |
| Deferred Revenue | $250,000 |
| Total Current Liabilities | $1,000,000 |
Working Capital = $2,000,000 - $1,000,000 = $1,000,000
Current Ratio = 2.0 (healthy)
Working Capital Ratios
Current Ratio
Measures ability to pay short-term obligations. Target: 1.5-2.0x
Quick Ratio (Acid Test)
More conservative—excludes inventory which may not convert to cash quickly. Target: 1.0+
Working Capital Turnover
How efficiently working capital generates revenue. Higher is generally better.
Why Working Capital Matters
Liquidity
Ensures you can pay employees, vendors, and lenders on time. Working capital problems lead to missed payments.
Growth Fuel
Growing businesses need working capital to fund larger inventory, more receivables, and expanded operations.
Borrowing Capacity
Lenders assess working capital when underwriting loans. Strong WC means better terms and higher limits.
Business Health
Working capital trends signal operational efficiency and financial stability to investors and acquirers.
The Growth Cash Trap
Fast-growing businesses often face working capital challenges. A company growing 50% may need 50% more inventory and will have 50% more receivables. Without proper planning, profitable growth can cause cash crises.
Optimizing Working Capital
Reduce Receivables (DSO)
- Invoice immediately upon delivery
- Offer early payment discounts (2/10 net 30)
- Require deposits on large orders
- Automate collections follow-up
Reduce Inventory (DIO)
- Improve demand forecasting
- Negotiate vendor consignment
- Reduce SKU count
- Implement just-in-time where possible
Extend Payables (DPO)
- Negotiate longer payment terms
- Use credit cards for float (if no fees)
- Time payments strategically
- Always pay on time to maintain relationships
Frequently Asked Questions
What's a good working capital ratio?
A current ratio (current assets / current liabilities) of 1.5-2.0 is generally healthy. Below 1.0 signals potential liquidity problems—you may not be able to pay near-term obligations. Above 3.0 might indicate excess cash that could be deployed more productively. Ideal ratios vary by industry.
Is negative working capital always bad?
Not necessarily. Some businesses with negative working capital are actually very healthy—they collect from customers before paying suppliers (like subscription businesses or retailers with fast inventory turn). Amazon operates with negative working capital. The key is whether it's intentional and sustainable or a sign of distress.
How does growth affect working capital?
Growth typically requires more working capital—you need more inventory, you have more receivables, and payables may not scale proportionally. A business growing 30% might need 30% more working capital. This is why profitable, fast-growing companies sometimes run out of cash.
What's the difference between working capital and cash flow?
Working capital is a balance sheet snapshot (what you have now). Cash flow is an income statement concept (what's coming in and going out over time). Strong working capital doesn't guarantee positive cash flow, and vice versa. You need to manage both.
Related Terms & Resources
Cash Conversion Cycle
How long cash is tied up
13-Week Cash Flow Template
Forecast working capital needs
EBITDA
Operating profitability metric
Fractional CFO Guide
Expert working capital management
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