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What Is Working Capital & How Do You Calculate It?

What Is Working Capital & How Do You Calculate It?
Susan Guillory
Susan GuilloryUpdated May 1, 2023
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Working capital is the money your business can access quickly to cover day-to-day operating expenses like salaries, inventory, and rent. Calculating and keeping a close eye on your working capital 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.

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 liabilities that need to be paid off within a year and can include:
  • Accounts payable
  • 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: Top Short-Term Small Business Loans in 2023

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 liabilities from assets. That way you get a dollar value for the liquid assets you’d have available after paying off current liabilities.Start by adding up your current assets.Then, separately, add up your current liabilities.Next use the following formula. Current Assets - Current Liabilities = Working CapitalLet’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:$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:Accounts receivable + Inventory - Accounts payable = Net Working capitalIn this case, let’s say you have $150,000 that’s owed to you by your clients and $150,000 in inventory, and you owe $100,000 to suppliers, your working capital is $200,000. ($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.Current Assets / Current Liabilities = Working Capital RatioLet’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:$300,000 / 100,000 = 3A 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 issueIn 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 growth.

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, or 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: Understanding Debt Factoring for Small Businesses

When Negative Working Capital Isn't a Problem

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.Recommended: Guide to Change in Net Working Capital

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’d 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 ready cash. If you have clients who are slow to pay you, this can also lower both cash flow and working capital. That’s why having a payment policy in place can be a good idea, since the faster you can get clients to pay, the more cash you have available.Recommended: Invoice Financing vs Invoice Factoring 

The Takeaway

Calculating and understanding working capital can help you make smart financial decisions for your business. If your working capital ratio is high and you have ideas about how to grow your business but need additional capital to do so, you might consider taking out a small business loanIf you're curious about what type of business financing you might qualify for, Lantern by SoFi can help. With our online lending tool, you can access a range of different small business loan options all in one place and receive an offer that’s matched to your needs and qualifications.Find the right financing solution for your small business on Lantern's marketplace.

Frequently Asked Questions

How is working capital calculated?
What is an example of working capital?
Why is working capital important?
Does working capital change over time?
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About the Author

Susan Guillory

Susan Guillory

Su Guillory is a freelance business writer and expat coach. She’s written several business books and has been published on sites including Forbes, AllBusiness, and SoFi. She writes about business and personal credit, financial strategies, loans, and credit cards.
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