Working capital is the money your business can access quickly to cover day-to-day operating expenses like salaries, inventory, and rent. Calculating your working capital and keeping a close eye on it is important because you want to make sure you always have enough available cash to cover your financial obligations.
Read on for a closer look at working capital, including what it is, how to calculate it, and what it means if your company has negative working capital.
Key Points
• Working capital is the difference between a company’s current assets and current liabilities, reflecting its ability to meet short-term obligations and maintain smooth operations.
• The basic formula to calculate working capital is Working Capital = Current Assets – Current Liabilities.
• Positive working capital means a company can cover its short-term debts, while negative working capital may indicate financial challenges or liquidity issues.
• Current assets include cash, inventory, and receivables, while current liabilities include accounts payable, short-term loans, and accrued expenses.
• If your business is struggling with working capital, you could consider cutting back on expenses, increasing profits, or taking out a working capital loan.
Recommended: What Is Adjusted EBITDA?
What Is Working Capital?
By definition, working capital is the difference between your business’s current assets and current liabilities.
Current assets are any assets that could be turned into cash within the year and can include:
• Cash in checking and savings accounts
• Mutual funds, bonds, stocks, and exchange-traded funds (ETFs)
• Inventory
• Accounts receivable
Current liabilities are short-term financial obligations that a business must settle within one year or its operating cycle, whichever is longer. Liabilities can include:
• Rent
• Utilities
• Supplies
• Loan payments
• Taxes
Because working capital is the difference between your business’s current assets and liabilities, it’s a measure of liquidity. Your working capital is the money that you have at hand and can use for expenses that can and likely will come up.
If you’re ever in the market for a small business loan, a lender will likely look at your company’s working capital since it tells them how likely it is that you will be able to repay your debts.
Recommended: 15 Types of Business Loans to Consider
Formula for Working Capital
Depending on why you’re figuring out your working capital, there are several ways to calculate it.
If you want to know how much working capital you have as a cash figure rather than a ratio, you simply subtract current liabilities from current assets. That way you get a dollar value for the liquid assets you’d have available after paying off current liabilities.
First, start by adding up your current assets.
Then, separately, add up your current liabilities.
Next, use the following formula:
Working Capital = Current Assets – Current Liabilities
Let’s say, for example, that your company has $300,000 in current assets and $100,000 in current liabilities. Then the following would be your calculation:
Working Capital = $300,000 – $100,000 = $200,000
Adjustments to the Working Capital Formula
The terms working capital and net working capital are often used interchangeably. However, sometimes analysts will use a more narrow definition and exclude most types of assets:
Net Working Capital = Accounts receivable + Inventory – Accounts Payable
In this case, let’s say you have $150,000 that’s owed to you by your clients and $150,000 in inventory. Assuming you owe $100,000 to suppliers, your net working capital is $200,000.
Net Working Capital = ($150,000 + $150,000) – $100,000 = $200,000
How to Figure Out Working Capital Ratio
The working capital ratio (also called current ratio) is a way to look at how much you have in current assets in comparison to how much you have in current liabilities. It simply involves dividing your business’s current assets by its current liabilities.
Start by adding up your current assets.
Then, separately, add up your current liabilities.
Working Capital Ratio = Current Assets / Current Liabilities
Let’s say, again, that your business has $300,000 in assets and $100,000 in liabilities.
To calculate your working capital ratio, you would do the following:
Working Capital Ratio = $300,000 / 100,000 = 3
A working capital ratio greater than one says that your current assets are greater than liabilities (something likely to appeal to lenders or investors). A lower ratio means cash is tighter, so a slowdown in sales could cause a cash flow issue.
In the above example, the ratio is 3, which is on the high end. This could be a sign that the company is holding on to too much cash when it could be investing it back into the business to fuel business growth.
Recommended: Guide to Trade Working Capital
Positive vs. Negative Working Capital
When you’re working to build business credit, you’ll likely want your business to have positive working capital. That means that the company has enough assets that could be quickly cashed out to cover all of its liabilities. It also means it’s more likely to be appealing to lenders as a loan applicant.
However, it’s also possible for a small business to have negative working capital. In this case, when you subtract liabilities from assets, you have a negative number. This might indicate that you’ve taken on more debt than you can afford or that your assets aren’t being used wisely.
If your business has negative working capital, you might find it difficult to qualify for a small business loan. You may need to pay a higher interest rate or make a larger down payment since the lender will likely perceive you as a greater risk.
Recommended: 6 Step Guide to Getting a Small Business Loan
Is Negative Working Capital Always Bad?
It’s normal for a company’s working capital to rise and fall as it handles its investments and expenses. A short-lived period of negative working capital usually isn’t a problem and can be easily turned around. It can simply indicate that the company had to make a large cash outlay or had a substantial increase in its accounts payable as a result of a large purchase of products and services from its vendors.
If negative working capital becomes a long-term issue, though, it can be a cause of concern, signaling that the company is struggling to make ends meet.
How Changes in Working Capital Affect Cash Flow
When you’re trying to understand working capital, it’s helpful to consider cash flow, too. That’s the cash and cash equivalents that flow in and out of your company.
Investors and lenders often look for a positive cash flow, meaning that your business is taking in more cash than it’s spending. This shows that your liquid assets are growing, so you can easily pay your liabilities.
Working capital and cash flow can impact one another.
For example, let’s say you decided to invest in commercial real estate for your business. Your cash flow would decrease because you’ve put some of your cash down on the property and taken out a loan for the rest. Your working capital would also decrease because some of the cash you included in your assets would be reduced. However, even though you took a loan out for the property, that’s a long-term liability rather than a current liability, so nothing would change for current liabilities in your working capital formula.
To take another example, if you were to sell a property, this would increase your cash flow and your working capital. That’s because you would have increased your available cash.
Recommended: What Are Working Capital Loans?
The Takeaway
Understanding and managing working capital is essential for maintaining a company’s financial health and operational efficiency. It measures a business’s ability to cover short-term obligations and sustain day-to-day operations. By calculating working capital — current assets minus current liabilities — businesses can assess their liquidity and make informed decisions about cash flow management.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How is working capital calculated?
To calculate working capital, you subtract your current liabilities (what you owe) from your current assets (what you have). This tells you whether you have enough cash to cover your short-term expenses and debts.
What is an example of working capital?
Working capital is the difference between a company’s current assets and current liabilities. For example, if you have $300,000 in current assets and $100,000 in current liabilities, your working capital would be:
Working Capital = $300,000 – $100,000 = $200,000
Why is working capital important?
Working capital provides insight into a company’s liquidity, operational efficiency, and short-term financial health. A high working capital ratio indicates that you have enough assets to cover your debts, and then some. A low ratio might suggest that you have more debt than you can afford. Lenders may look at how much working capital you have to determine how risky you are as a borrower.
Does working capital change over time?
Yes, working capital changes over time because a company’s current liabilities and current assets will fluctuate over the course of a year.
Photo credit: iStock/SeanShot
SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
SOSMB-Q424-030