Working Capital

Working capital is one of the simplest but most important financial metrics for any small business. The formula is: Working Capital = Current Assets - Current Liabilities. Current assets include cash, accounts receivable, and inventory — anything that will be converted to cash within 12 months. Current liabilities include accounts payable, credit card balances, and the current portion of loans — anything you need to pay within 12 months.

Positive working capital means you have more short-term assets than short-term obligations — you can pay your bills and still have room to operate. Negative working capital means you owe more in the short term than you have available — a danger sign that you might not be able to meet your obligations without borrowing or selling assets.

The working capital ratio (also called the current ratio) divides current assets by current liabilities. A ratio of 1.0 means you're exactly breaking even on short-term obligations. Below 1.0, you're in trouble. Above 2.0, you're in a comfortable position. Between 1.2 and 2.0 is the healthy range for most small businesses. Too high (above 3.0 or 4.0) might mean you have too much cash sitting idle or too much inventory gathering dust — money that could be invested in growing the business.

Working capital is your business's financial cushion. It determines whether you can handle unexpected expenses, take on new orders that require upfront investment, or survive a slow month. Banks scrutinize your working capital when evaluating loan applications because it shows whether you can handle additional debt obligations. Vendors may check your working capital before extending credit terms. And for seasonal businesses, managing working capital throughout the year is critical — you might need to build inventory before your peak season, which temporarily reduces working capital. Planning for these cycles prevents panic borrowing at unfavorable terms.