How To Calculate Working Capital Formula
Working Capital Formula: Working capital tells stakeholders and investors whether or not your company has enough liquidity to pay upcoming expenses. To determine your working capital, start by finding your current assets and liabilities. Then subtract those total amounts from each other.
Additional Formula Methods: There are two other working capital styles: Working Capital Ratio and Working Capital Cycle. These help to determine your company's financial health and how long it takes to turn assets into cash.
Building Strong Capital: Improve your working capital by reducing your accounts receivable days, streamlining your inventory management processes, and optimizing your accounts payable.
Many companies look great on paper but struggle to cover everyday expenses behind the scenes. More often than not, this dilemma usually comes down to tight working capital. The solution? Learn the working capital formula and how to leverage it to keep your business liquid.
As a financial controller, I’ve seen how working capital can either make or break a business. In this guide, I break down the working capital formula and share practical examples that finance pros like you can use to avoid a cash-strapped business.
What Is Working Capital?
Working capital is what you have left after deducting your company’s current liabilities from its current assets. Also called net working capital (NWC), your business’s working capital shows whether or not it has enough liquidity to pay upcoming bills comfortably.
In knowing your working capital, you can take the necessary steps to maintain healthy finances or resolve ongoing cash flow issues in day-to-day operations.
The Working Capital Formula (+ What’s Included)
Here’s the most common formula companies use to find the amount of working capital:
Working Capital = Current Assets - Current Liabilities
But a formula doesn’t help entirely if you’re not sure what your assets or liabilities are. Let’s take a closer look at what each of these formula elements means.
- Current Assets: Things your business owns that you can quickly convert to cash or use up within a year. For example, accounts receivables and inventory.
- Current Liabilities: Debts and expenses your company needs to pay within a year like short-term loans, salaries, and taxes.
The graphic below covers more examples of current assets and current liabilities to aid your calculation accuracy.
How To Use The Working Capital Formula
The working capital formula is a great start, but how exactly do you use it? Let’s start with an example:
Say you’re the finance manager at a manufacturing company looking to secure a business loan. The bank wants to know your working capital to confirm your liquid assets and ability to pay back. In the last quarter, you recorded these numbers:
| Current Assets | Amount |
| Cash | $230,000 |
| Accounts receivable | $165,000 |
| Finished goods | $110,000 |
| Total: | $505,000 |
| Current Liabilities | Amount |
| Wages and salaries | $165,000 |
| Accounts payable | $100,000 |
| Short-term loans | $50,000 |
| Total: | $315,000 |
With these figures, you’d use the working capital formula, subtracting your total current assets from your total current liabilities.
$505,000 − $315,000 = $190,000
By proving that your business is liquid enough—with $190,000 working capital that can easily handle daily operations and support loan repayment—the lender is likely to give you a chance.
Or, imagine you handle accounting for an editing software company that a bigger media brand wants to buy. To solidify their decision, they want to know that your books, including financial metrics like working capital, are in order. In the past year, your financial statements show the following numbers:
| Current Assets | Amount |
| Cash | $320,000 |
| Accounts receivable | $210,000 |
| Short-term investments | $150,000 |
| Total: | $680,000 |
| Current Liabilities | Amount |
| Accounts payable | $140,000 |
| Deferred revenue | $120,000 |
| Operational expenses (due soon) | $90,000 |
| Total: | $350,000 |
Using the formula, your working capital will be:
$680,000 − $350,000 = $330,000
Your company’s working capital of $330,000 reveals strong liquidity and proves to the potential buyer your company’s ability to cover short-term obligations and maintain financial stability. This status makes your business a low-risk acquisition, increasing the chances of a successful deal.
Other Types of Working Capital Formulas
The standard working capital formula is only one type of working capital. There are also other methods that you should be aware of, depending on your business model and need requirements.
The Working Capital Ratio
Like the working capital formula, the working capital ratio is a measure of a company’s financial health. It reveals your business’s ability to pay off short-term liabilities with your company’s short-term liquidity.
Also called the current ratio, you can find it by dividing the business’s current assets by its current liabilities.
Working Capital Ratio = Current Assets ÷ Current Liabilities
A working capital ratio above 1 is good because it means you have more than enough current assets than liabilities (i.e. positive working capital). If your current ratio drops below 1 though (negative working capital), that’s a red flag indicating that your company may struggle to cover short-term debts and financial obligations.
The Working Capital Cycle
The working capital cycle is how long it takes for your business to turn its current assets into enough cash for operational activities.
Working Capital Cycle = Inventory Days + Receivables Days − Payables Days
Also called the operational cycle, it is broken down into three stages:
- Inventory Turnover: How long it takes you to sell inventory.
- Receivables Collection: How long it takes you to collect payments from customers.
- Payables Payment: How long it takes you to pay suppliers for goods and services.
A short working capital cycle is a valuation that shows that your business can quickly turn its resources into cash. Meanwhile, a long cycle is typically a sign of operational inefficiency.
3 Mistakes to Avoid When Calculating Working Capital
Leveraging working capital goes beyond just knowing the formula and what goes into it—you also need to watch out for the following calculation pitfalls:
- Not Accounting For Seasonal Fluctuations: If you don’t factor seasonal cash flow changes in your working capital calculation, the figure you get can misrepresent liquidity. Always analyze trends, not just one-time snapshots.
- Overestimating Receivables: Recording overdue or unpaid invoices as guaranteed cash can exaggerate your working capital. Focus on realistic collections, not just outstanding payments.
- Ignoring Short-Term Debt Maturities: When you exclude upcoming loan payments from your working capital equation, you skew the real picture. Always account for near-term obligations when assessing your company’s available funds.
How to Sustain and Improve Your Working Capital
If your working capital isn’t where you want it to be, don’t panic. The following strategies will help you turn things around in no time.
1. Reduce Your Accounts Receivable Days
The earlier you collect payments, the more cash you have to cover expenses and invest in growth.
Say you currently allow 60 days for invoices. Consider shortening the payment term to 30 days by offering early payment discounts, enforcing stricter credit terms, or automating reminders. Once done, you’ll get payments faster and can instantly use them to pay suppliers, fund operations, and expand your business.
2. Improve Your Inventory Management
Excess stock ties up your cash, while too little can lead to untimely stockouts. Striking the right balance is the best way to ensure a healthy inventory turnover.
For example, if you overstock smartphones in an electronics store, you tie up cash that could be useful elsewhere. Meanwhile, not having enough of these phones on hands can mean losing sales to competitors during high-demand periods.
Manage your inventory more efficiently by analyzing past sales and forecasting demand to optimize your purchasing and stock levels.
3. Optimize Your Accounts Payable
Paying suppliers and creditors too quickly drains cash. At the same time, delaying payments too much can attract penalties and damage relationships. My best advice? Do a cost-benefit analysis and act accordingly.
Imagine having a supplier that gives you up to 30 days to pay them but also extends a 2% discount for early payment. Weigh the savings against the benefits of keeping cash available and go with the most efficient option.
If paying a vendor on time puts a strain on your liquidity, it might be smarter to wait until the due date and forfeit any early payment discount.
Benefits and Limitations of Working Capital
One of the top financial KPIs, working capital is a major business stability and growth driver. But, it also has limitations. Keep reading, and I’ll walk you through both the ups and downs of working capital so you can maximize it.
Benefits of Working Capital
Here’s a deeper dive into the benefits listed on the graphic above:
- Liquidity Management: Strong working capital gives you the liquidity to cover short-term obligations without constantly worrying about cash flow. It helps you pay suppliers on time, manage payroll effectively, and handle everyday expenses with ease. You’ll also avoid the crippling loans and high-interest borrowing that are the hallmark of businesses with cash flow issues.
- Operational Efficiency: A healthy working capital balance lets you optimize inventory, manage supplier payments strategically, and keep business operations running with minimal disruptions. And, with the right financial analytics tool, you can track it and other KPIs so you can find the sweet spot between optimal inventory and strong liquidity.
- Creditworthiness: The more your working capital, the better your financial reputation. This means that banks and other lenders will see you as a low-risk borrower, making it easier to secure financing at great rates.
- Flexibility: Working capital gives you the financial flexibility to make strategic, forward-thinking decisions that wouldn’t be possible otherwise. It keeps your company agile, adaptable, and primed for growth. So if you need to hire more staff during a busy season for example, you can do so confidently, knowing you have the cash to handle payroll. And if unexpected expenses arise (like equipment repairs), you can handle them like a boss.
Limitations of Working Capital Formula
The working capital formula is great, but it isn’t completely failproof. A high working capital doesn’t always indicate financial health just like a low value isn’t necessarily a sign of distress. Specifically, here are a couple of reasons why the KPI can be misleading:
- Changing Values: Working capital shows the state of your finances at a single moment, but business conditions change constantly. A large client payment may improve your numbers today while an upcoming supplier invoice could quickly reverse that. Essentially, cash flow fluctuations, seasonal trends, and unexpected expenses all affect your finances. Get the true picture of things by analyzing your working capital over time instead of relying on a single, potentially-misleading calculation.
- Unequal Assets: The working capital formula treats all current assets as equal—inventory, receivables, cash, etc—yet you can’t turn them all into cash as easily as the other. For example, slow-moving inventory or late payments can leave you scrambling for funds at critical times. To see how liquid your assets truly are, look beyond the numbers to the actual context behind each one. The million-dollar questions? How fast can I turn this asset to cash? And, can I truly rely on it as part of my financial safety net?
- Asset Devaluation: Your balance sheet may show a solid working capital position, but assets like inventory or certain currencies can lose their value due to market shifts, obsolescence, or discounting. Regularly access the actual value of your assets to avoid misleading conclusions, like thinking your financial health is better than it actually is.
- Long-term Obligations: Working capital focuses on short-term assets, liabilities, and obligations—all while ignoring long-term financial commitments. This incomplete perspective can give a false sense of security, especially if you have significant long-term debt or future financial responsibilities that the calculation doesn’t cover. Always factor in your long-term payables when analyzing financial health for a more comprehensive view.
3 Ways to Further Streamline Your Working Capital
Working capital doesn’t have to be a challenge. Here are some more ways to improve your working capital management efficiency.
Practice Financial Modeling
Optimize your working capital through financial modeling. This process involves creating a detailed representation of your company's financial situation, via spreadsheets, Excel, or specialized software, and tracking where your money is really going.
Automate the Bookkeeping Process
Automating financial management, including working capital optimization, is a core passion for my team and I and this entire site is a testament to that commitment. The reason is simple: technology makes everything easier. And while human input and guidance remain critical, the right tools make all the difference when it comes to crunching numbers.
Accounting software simplifies bookkeeping, forecasting tools provide clear insights into future cash flow, and budgeting apps support efficient resource allocation. The result? Proper planning, optimal spending, on-time payments, and huge savings—especially if you use tools that easily integrate with each other.
Use a Business Line of Credit Wisely
A line of credit comes in quite handy when you have little to no working capital. But, the trick to successful debt financing is strategic application—only when necessary and with a clear repayment plan. With borrowed funds, you can quickly cover short-term gaps and tide your business over till cash flow improves.
Now What?
Bottom line: the working capital formula and other strategies shared here have worked wonders for me everywhere I’ve worked and I’m sure it’ll do the same for you.
But financial management is an ongoing process. So if you want to keep learning and growing through expert insights from finance pros like you and I, subscribe to our free newsletter today.