Working Capital
Also: Net Working Capital, NWC
Working capital is the difference between a company's current assets and current liabilities, measuring short-term liquidity and the funds available to run daily operations.
What It Is
Working capital is a measure of a company's short-term financial health. It is calculated with a simple formula:
Working Capital = Current Assets, Current Liabilities
Current assets are resources expected to be converted to cash within one year (cash, accounts receivable, inventory, prepaid expenses). Current liabilities are obligations due within one year (accounts payable, short-term debt, accrued expenses, the current portion of long-term debt).
A positive working capital means a company can cover its near-term obligations with its near-term assets. A negative working capital signals possible liquidity stress, though some efficient business models (for example, fast-turnover retail) operate comfortably with negative working capital.
Why it matters
- Liquidity: It shows whether a business can pay bills, suppliers, and payroll without raising new financing.
- Operational runway: It funds the gap between paying for inputs and collecting from customers.
- Growth signal: Rapid growth often consumes working capital because inventory and receivables rise before cash arrives.
- Lender and investor view: Banks and investors use it (and related ratios) to assess solvency risk.
How it is used in practice
Finance teams monitor working capital alongside the current ratio (current assets / current liabilities) and the cash conversion cycle (days inventory + days receivables, days payables). CFOs actively manage it by:
- Negotiating longer payment terms with suppliers (raising payables).
- Collecting receivables faster (tightening credit terms, invoicing earlier).
- Reducing excess inventory.
The goal is usually to free up cash without disrupting operations.
Concrete Example
A manufacturer has:
- Current assets: cash 50k, receivables 120k, inventory 130k = 300k
- Current liabilities: payables 90k, short-term debt 60k = 150k
Working capital = 300k, 150k = 150k.
The current ratio is 300k / 150k = 2.0, a healthy buffer. If the firm doubled sales next quarter, receivables and inventory would likely grow, consuming cash and requiring either faster collections or additional financing to avoid a squeeze.
Frequently asked questions
How is working capital calculated?
Working capital = current assets − current liabilities. Current assets are what converts to cash within a year (cash, receivables, inventory, prepaid expenses); current liabilities are what comes due within a year (payables, short-term debt, accrued expenses, the current portion of long-term debt). A manufacturer with 300k of current assets and 150k of current liabilities has 150k of working capital.
Is negative working capital always a bad sign?
No. Negative working capital often signals liquidity stress, but some business models run on it comfortably, typically fast-turnover retail where customers pay immediately and suppliers are paid later. What matters is whether the model structurally generates cash before it has to spend it, not the sign of the number alone.
What is the difference between working capital and the current ratio?
Working capital is an absolute amount (current assets minus current liabilities), the current ratio is the same comparison expressed as a division (current assets / current liabilities). With 300k of current assets and 150k of current liabilities, working capital is 150k and the current ratio is 2.0. The ratio makes companies of different sizes comparable; the amount tells you how much cash cushion exists.
Why does growth consume working capital?
Because inventory and receivables rise before the cash from those sales arrives. A company that doubles its sales buys or produces more stock and invoices more customers, both of which tie up cash while payment terms run. That is why fast-growing firms can be profitable and still face a cash squeeze, requiring faster collections or additional financing.
What levers does a CFO have to free up working capital?
Three levers: negotiate longer payment terms with suppliers to raise payables, collect receivables faster by tightening credit terms and invoicing earlier, and cut excess inventory. Each releases cash, and the constraint is doing it without disrupting operations or supplier relationships. Progress is tracked through the cash conversion cycle (days inventory + days receivables − days payables).