Definition
Working capital is the difference between a business's current assets, such as cash, receivables and inventory, and its current liabilities, such as payables, short-term loans and taxes due within a year. It measures the short-term cushion available to run daily operations, and changes in it explain much of the gap between profit and cash.
How it works
Positive working capital means current assets cover short-term obligations; negative working capital can be a warning sign, although some businesses, such as supermarkets that are paid before they pay suppliers, run safely with it. The current ratio, current assets divided by current liabilities, expresses the same idea as a ratio.
In the indirect cash flow statement, an increase in receivables or inventory uses cash and a decrease releases it, while an increase in payables provides cash. A growing, profitable company can still run out of cash if customers pay slowly or stock piles up.
To free up working capital, invoice promptly, shorten collection terms, cut slow-moving stock and negotiate supplier terms. The cash conversion cycle calculator shows how many days cash is tied up, and the financial statements guide explains the cash flow adjustments.
Formula
Working capital = Current assets - Current liabilities
Current ratio = Current assets ÷ Current liabilities
Example: working capital and cash
A company has current assets of 500,000 and current liabilities of 300,000: working capital of 200,000 and a current ratio of 1.67.
During the year profit is 120,000, but receivables grow by 70,000 and inventory by 40,000 while payables grow by 10,000. Operating cash flow before other items is 120,000 - 70,000 - 40,000 + 10,000 = 20,000.