Working capital

The formula

• WC = CA − CL

CA is the current assets, everything expected to become cash within a year, and CL the current liabilities, everything due within a year. The difference is the money the business has to run on once the year’s debts are met.

A worked example

Current assets of 800,000 and current liabilities of 500,000: WC = 800,000 − 500,000 = 300,000. Turned round, a business that wants 300,000 of working capital with 650,000 of current liabilities needs current assets of 950,000.

An amount, not a ratio

The same two figures divided instead of subtracted give the current ratio: 800,000 / 500,000 = 1.6. The ratio compares companies of different sizes; the amount says how much cash a particular company has in play, and how much more growth will need. A business whose sales double usually needs roughly double the working capital, which is cash that has to come from somewhere.

Negative working capital

Current liabilities above current assets is not always distress. A supermarket or a subscription business is paid by its customers before it pays its suppliers, and runs on their money with a negative figure by design; see the cash conversion cycle. For a business that sells on credit and holds stock, the same sign means the year’s bills exceed what can be raised to pay them.

Common mistakes

• Counting long-term items. A loan due in three years, or a building, belongs in neither figure.
• Treating it as a fixed number. It changes every day as stock is bought and invoices paid; a balance sheet gives one date.
• Reading more as better without limit. Excess working capital is cash that earns nothing and stock that waits.

Frequently asked questions