Working capital
Current assets minus current liabilities: the short-term resources a business has to fund its day-to-day operations.
In short
- Positive working capital means short-term assets cover short-term obligations.
- Receivables, inventory and payables are where most of it is tied up.
- Growing businesses often need more working capital before profits arrive.
Working capital = Current assets − Current liabilities Current ratio = Current assets ÷ Current liabilities
Operating working capital is often measured as receivables plus inventory minus payables, leaving out cash and debt.
Working capital measures the cushion a business has to run its operations. It takes everything that should turn into cash within a year, such as cash, receivables and inventory, and subtracts everything that must be paid within a year, such as payables, accrued liabilities and short-term debt.
Reading it
Positive working capital means current assets exceed current liabilities. The business should be able to meet its short-term obligations. Negative working capital can signal trouble, but not always: some retailers and subscription businesses collect cash from customers before paying suppliers, and run negative working capital comfortably.
Where it gets tied up
Operating working capital is driven by three balances. Receivables grow when customers pay slowly. Inventory grows when stock sits too long. Payables shrink when suppliers are paid early. Each ties up cash that could otherwise be used elsewhere, which is why days sales outstanding, days inventory and days payable are managed so closely.
Growth needs working capital
A profitable business can still run short of cash while it grows. Selling more usually means holding more inventory and carrying more receivables before customers pay. That extra working capital has to be funded, by profits, by stretching payables within terms or by borrowing, often before the new sales produce any cash.
Worked example
A wholesaler's working capital
A wholesaler has $120,000 in cash, $540,000 of receivables and $610,000 of inventory, a total of $1.27 million in current assets. Current liabilities are $480,000 of payables, $95,000 of accruals and $150,000 due on its line of credit, a total of $725,000. Working capital is $545,000 and the current ratio is about 1.75.