What Is Working Capital? Formula and Examples

Working capital is what a company has available to fund day-to-day trading: current assets minus current liabilities. It measures whether the resources that will turn into cash within a year cover the obligations that will fall due in the same year.

Working capital = Current assets − Current liabilities

It is the most practical number on the balance sheet, because it answers a question with a deadline attached: can we get through the next twelve months without needing money we don't have?

A worked example

The company used throughout these articles, at 31 December, in euros:

Current assets		Current liabilities
Inventory	12,500	Trade payables	8,400
Trade receivables	9,300	VAT payable	2,100
Cash and bank	6,200	Payroll liabilities	2,700
		Deferred income	3,500
Total	28,000	Total	16,700

Working capital = 28,000 − 16,700 = 11,300 €.

Positive, which is the baseline expectation: the assets converting to cash this year exceed the obligations falling due. But the headline number alone hides the shape of it, which is where the ratios come in.

The ratios that matter

Current ratio = current assets ÷ current liabilities = 28,000 ÷ 16,700 = 1.7

Above 1 means short-term resources exceed short-term obligations. The old textbook rule of "2 is healthy" is worth ignoring — a supermarket collecting cash instantly and paying suppliers in 60 days operates comfortably below 1, while a project business with slow-paying clients can be stretched at 2.

Quick ratio (acid test) = (current assets − inventory) ÷ current liabilities = (28,000 − 12,500) ÷ 16,700 ≈ 0.9

This drops the least liquid asset. The gap between 1.7 and 0.9 is the whole story of this company: nearly half its current assets are stock, and stock only becomes cash if someone buys it. A quick ratio below 1 is not fatal, but it means the next few months depend on selling inventory, not just collecting invoices.

Working capital against revenue = 11,300 ÷ 180,000 ≈ 6.3%

Useful for planning growth: if revenue doubles and working capital stays proportional, the business needs roughly 11,300 € more funding just to trade at the new level. Growth consumes cash, and this ratio is how much.

What "current" actually means

The twelve-month rule decides everything, and it is applied line by line rather than to whole balances:

• The portion of a bank loan due within the next year is a current liability, even if the loan runs for a decade. The rest is non-current.
• Inventory is current even if it has sat in the warehouse for two years — but see the aging caveat below.
• Deferred income (cash received for undelivered work) is a current liability, not revenue. Our example carries 3,500 € of it: money already banked that still has to be earned. It reduces working capital, correctly, because delivering that work will consume resources.

Reading it honestly

The formula is arithmetic; the interpretation needs the detail behind each line.

• Receivables quality. 9,300 € of invoices is only worth 9,300 € if customers pay. An aging report splits it into current and overdue buckets — 9,300 € of which 4,000 € is 90 days overdue is a materially weaker position than the balance sheet suggests, and the difference is a bad-debt provision waiting to be recognized through adjusting entries.
• Inventory quality. Same logic. Stock aging tells you whether 12,500 € is fast-moving goods or slow-moving capital.
• Trend beats level. Working capital rising because receivables are ballooning is a warning; rising because cash is accumulating is not. One snapshot cannot tell these apart; two consecutive ones can.
• Negative isn't automatically bad. Businesses collecting cash at the point of sale and paying suppliers on terms — retail, restaurants, subscription software billed annually in advance — routinely run negative working capital and are financed by their own suppliers and customers. Negative working capital in a business that invoices on 30-day terms is a different matter entirely.

The cash conversion cycle

Working capital measured in euros tells you the amount; measured in days it tells you the cause:

Cash conversion cycle = days inventory outstanding
                      + days sales outstanding
                      − days payables outstanding

For the example, roughly: inventory of 12,500 € against 104,000 € of annual cost of sales is about 44 days of stock; receivables of 9,300 € against the year's invoiced sales is about a fortnight; payables of 8,400 € against purchases is perhaps 25 days. That nets to a cycle of roughly five weeks — the period the company funds trading out of its own pocket before the money comes back.

Every day removed from that cycle releases cash permanently. That is why collecting faster, holding less stock and negotiating supplier terms are the three levers that fund growth without borrowing — and why they usually beat cost-cutting for cash impact.

Where the numbers come from

All of it derives from the ledger, with no manual assembly:

• POST /v1/reports/financial-statements returns the balance sheet with current assets already split into inventories, receivables, other current assets and cash, and liabilities split into current and non-current — the two totals the formula needs.
• POST /v1/reports/debt-aging { side: 'receivables' | 'payables' } gives the aging buckets behind those totals, per partner.
• POST /v1/reports/stock-balance and /v1/reports/stock-aging do the same for inventory.

One caveat worth knowing: the current/non-current split in the statements is derived from the chart of accounts structure, so a loan's current portion is only classified correctly if it is actually posted to a current-liability account. If long-term debt sits entirely in the non-current group, working capital will look better than it is — a five-minute check worth doing once.

FAQ

What is the working capital formula?

Current assets minus current liabilities. "Current" means expected to be realized or settled within twelve months, applied line by line — including the portion of long-term debt falling due in the next year.

What is a good working capital ratio?

It depends entirely on the trade. Above 1 is the general baseline, but retail and subscription businesses operate healthily below it while project businesses can be tight above 2. Compare against your own history and direct competitors rather than a textbook number.

What is the difference between the current ratio and the quick ratio?

The quick ratio excludes inventory from current assets, on the basis that stock is the hardest current asset to turn into cash quickly. A large gap between the two ratios tells you how dependent the company's short-term position is on selling inventory.

Can working capital be too high?

Yes. Excess working capital is idle capital — cash sitting still, stock nobody is buying, customers taking too long to pay. It is safer than too little, but it is money financing itself rather than the business.

Does working capital include deferred income?

Yes, as a current liability. Cash received for goods or services not yet delivered is an obligation to perform, not revenue, so it correctly reduces working capital until the delivery happens.