Finance
Fact-checked

At SmartCapitalMind, we're committed to delivering accurate, trustworthy information. Our expert-authored content is rigorously fact-checked and sourced from credible authorities. Discover how we uphold the highest standards in providing you with reliable knowledge.

Learn more...

How do I Calculate Working Capital?

Calculating working capital is straightforward: subtract your current liabilities from your current assets. This figure represents your company's operational liquidity and short-term financial health. A positive working capital indicates the ability to fund day-to-day operations and invest in growth. But what does it mean when the number is negative? Join us as we examine the implications for your business.
Osmand Vitez
Osmand Vitez

Working capital is a financial figure that represents the liquidity of a business based on available current assets and current liabilities. To calculate working capital, simply subtract a company’s total current assets from total current liabilities. For example, if a company has $1 million United States Dollars (USD) in current assets and $750,000 USD in current liabilities, working capital is $250,000 USD. While this example indicates working capital as a positive figure, it is possible to have negative working capital during the lifetime of a business.

When attempting to calculate working capital for a company, one can obtain all of the necessary information from the balance sheet. Current assets are typically listed first on the balance sheet. This number includes cash and cash equivalents, accounts receivable, inventory, prepaid accounts, and short-term investments. The last two items are only included in current assets if they expire in 12 months or less. Analysts and investors use current assets to calculate working capital because these items represent assets that are easier to turn into cash than other items owned by the company.

Working capital may be established by subtracting total assets from liabilities.
Working capital may be established by subtracting total assets from liabilities.

Current liabilities are items that companies are financially obligated to pay within the next 12 months. These items include accounts payable and short-term loans such as credit lines, credit cards, and other short-term debt obligations. These debts typically arise because of normal operations in business. Although these items are not commonly secured by collateral, they do represent legal obligations that must be paid.

Analysts and investors use current assets to calculate working capital because these items represent assets that are easiest to turn into cash.
Analysts and investors use current assets to calculate working capital because these items represent assets that are easiest to turn into cash.

Financial analysts and accountants may use a working capital ratio when attempting to calculate working capital. This ratio provides a statistical indicator to compare against the industry standard or leading competitor’s working capital ratio. The ratio used to calculate working capital is current assets divided by current liabilities. Using the figures from the previous example, a company’s working capital ratio is 1.33 (1,000,000 / 750,000). If this figure is less than 1.0, it indicates the company has negative working capital. A figure over 2.0 may signal a company has excessive assets and is not using them to generate more capital. Therefore, an ideal working capital ratio is between 1.0 and 2.0.

Cash on hand is considered working capital.
Cash on hand is considered working capital.

Using the working capital ratio provides a different level of understanding for company management. Changing the current asset figure from the previous example, assume current assets of $2,000,000 USD and current liabilities of $750,000 USD. While the working capital formula indicates positive working capital of $1,250,000 USD (2,000,000 – 750,000), the ratio is 2.67 (2,000,000 / 750,000). Therefore, company management may need to use the company’s short-term assets to generate higher revenues.

You might also Like

Discuss this Article

Post your comments
Login:
Forgot password?
Register:
    • Working capital may be established by subtracting total assets from liabilities.
      By: Petrik
      Working capital may be established by subtracting total assets from liabilities.
    • Analysts and investors use current assets to calculate working capital because these items represent assets that are easiest to turn into cash.
      By: endostock
      Analysts and investors use current assets to calculate working capital because these items represent assets that are easiest to turn into cash.
    • Cash on hand is considered working capital.
      By: fotoatelie
      Cash on hand is considered working capital.