Finance⏱ 5 min read
What Is Working Capital and How Do You Calculate It?
Working capital tells you whether a business can pay its short-term obligations. Here's how to calculate it, what a healthy ratio looks like, and the warning signs that matter most.
Working capital is the difference between what a business owns short-term and what it owes short-term. It's the measure of operational liquidity — whether the business can meet its obligations without needing additional financing.
The Formula
Working Capital = Current Assets - Current Liabilities
Current Assets (owned, convertible to cash within 12 months):
- Cash and bank balances
- Trade receivables (money owed by customers)
- Inventory / stock
- Prepayments and short-term deposits
Current Liabilities (owed, due within 12 months):
- Trade payables (money owed to suppliers)
- Bank overdraft
- Short-term loans and credit facilities
- Tax liabilities due
- Accruals
Worked Example
Manufacturing company balance sheet extract:
Current Assets:
Cash: £45,000
Trade receivables: £120,000
Inventory: £85,000
Total: £250,000
Current Liabilities:
Trade payables: £95,000
Bank overdraft: £30,000
Tax due: £18,000
Total: £143,000
Working Capital = £250,000 - £143,000 = £107,000
Current Ratio = Current Assets / Current Liabilities
= £250,000 / £143,000 = 1.75
A current ratio above 1.0 means positive working capital.
Ideal range: 1.2-2.0 for most businesses.
Quick Ratio (Acid Test)
Quick Ratio = (Current Assets - Inventory) / Current Liabilities
Removes inventory because it may not be quickly convertible to cash.
More conservative than the current ratio.
= (£250,000 - £85,000) / £143,000
= £165,000 / £143,000 = 1.15
Ideal quick ratio: above 1.0
Below 1.0: business depends on selling inventory to pay bills
This matters more in sectors with slow-moving stock
(construction, retail) and less in service businesses with no inventory.
Warning Signs in Working Capital
IndicatorWarning SignLikely Problem
Current ratio below 1.0Negative working capitalCannot meet short-term obligations
Receivables rising faster than salesCustomers paying slowerCash flow squeeze ahead
Inventory building upStock not sellingCash tied up unproductively
Payables rising without revenue riseDelaying supplier paymentsFunding operations with credit
The Working Capital Cycle
Cash Conversion Cycle (CCC) = Days Inventory + Days Receivable - Days Payable
Days Inventory = (Inventory / COGS) x 365
Days Receivable = (Receivables / Revenue) x 365
Days Payable = (Payables / COGS) x 365
Example:
Days Inventory: 45 days (stock sits 45 days before sold)
Days Receivable: 38 days (customers take 38 days to pay)
Days Payable: 30 days (business pays suppliers in 30 days)
CCC = 45 + 38 - 30 = 53 days
This business needs 53 days of working capital funded between
paying for materials and receiving payment from customers.
Negative CCC (like many retailers) means customers pay before
the business pays suppliers — a very healthy position.