Calculate business liquidity, current ratio, quick ratio, and cash conversion cycle instantly. Analyze your company's short-term financial health and operational efficiency.
This fundamental formula calculates the net working capital available to fund day-to-day operations.
Measures a company's ability to pay short-term obligations with current assets. A ratio above 1 indicates more current assets than liabilities.
A more conservative liquidity measure that excludes inventory, which may not be quickly convertible to cash.
Shows the percentage of sales that is tied up in working capital. Lower ratios indicate more efficient use of working capital.
Below is an example of how working capital calculations work for a hypothetical manufacturing company:
| Financial Component | Amount | Calculation Notes |
|---|---|---|
| Cash & Equivalents | $50,000 | Bank balances and liquid investments |
| Accounts Receivable | $75,000 | Money owed by customers (30-day terms) |
| Inventory | $100,000 | Raw materials and finished goods |
| Other Current Assets | $25,000 | Prepaid expenses and short-term investments |
| Total Current Assets | $250,000 | Sum of all current assets |
| Accounts Payable | $60,000 | Money owed to suppliers (45-day terms) |
| Short-term Debt | $40,000 | Bank loans due within one year |
| Other Current Liabilities | $30,000 | Accrued expenses and taxes payable |
| Total Current Liabilities | $130,000 | Sum of all current liabilities |
| Net Working Capital | $120,000 | $250,000 - $130,000 = $120,000 |
| Current Ratio | 1.92 | $250,000 ÷ $130,000 = 1.92 |
| Quick Ratio | 1.15 | ($250,000 - $100,000) ÷ $130,000 = 1.15 |
This company has positive working capital of $120,000, indicating it has sufficient short-term assets to cover its short-term liabilities. The current ratio of 1.92 is within the healthy range (1.5-2.0), suggesting good liquidity. The quick ratio of 1.15 shows the company can meet its immediate obligations without selling inventory.
Business Implications: With this working capital position, the company can comfortably fund day-to-day operations, take advantage of early payment discounts from suppliers, and potentially invest in growth opportunities without relying on external financing.
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Working capital is the difference between a company's current assets and current liabilities. It represents the liquid assets available to fund day-to-day operations and meet short-term obligations.
Importance: Adequate working capital ensures a business can pay suppliers, employees, and other short-term debts. It also provides flexibility to take advantage of opportunities, manage seasonal fluctuations, and maintain operations during economic downturns. Insufficient working capital can lead to liquidity crises, missed opportunities, and potential insolvency.
The working capital ratio (also called current ratio) is calculated by dividing current assets by current liabilities:
Interpretation:
Positive Working Capital: Occurs when current assets exceed current liabilities. This indicates the company has sufficient short-term resources to cover its obligations and fund operations. Most healthy businesses maintain positive working capital.
Negative Working Capital: Occurs when current liabilities exceed current assets. While sometimes strategic (e.g., Walmart's efficient inventory management), generally it signals potential liquidity problems. The company may need to rely on external financing or asset sales to meet short-term obligations.
Industry Variations: Some industries (like grocery retail) operate successfully with negative working capital due to fast inventory turnover and favorable payment terms with suppliers.
Businesses can improve working capital through several strategies:
The Cash Conversion Cycle (CCC) measures how long it takes for a company to convert its investments in inventory and other resources into cash flows from sales. It's calculated as:
Where:
Relationship to Working Capital: A shorter CCC means the company is more efficient at converting investments into cash, requiring less working capital. A longer CCC ties up more cash in operations, increasing working capital requirements. Businesses aim to minimize CCC while maintaining sufficient inventory and customer credit terms.
Working capital represents the operational liquidity available to a business for day-to-day expenses. It's calculated as the difference between current assets (cash, accounts receivable, inventory) and current liabilities (accounts payable, short-term debt). Effective working capital management is crucial for maintaining business solvency, funding growth, and optimizing operational efficiency.
Professional financial analysis examines several working capital metrics:
Working capital needs vary significantly across industries. Manufacturing businesses typically require more working capital due to inventory requirements and longer production cycles. Service businesses often need less working capital as they have minimal inventory. Retail businesses may operate with negative working capital by collecting customer payments before paying suppliers.
Businesses can optimize working capital through several strategies:
When internal working capital is insufficient, businesses can access several financing options:
Working capital efficiency directly impacts business valuation. Companies with optimal working capital management typically demonstrate:
Valuation models often adjust for excess or deficient working capital, as both can signal operational inefficiencies that affect future cash flows and risk profiles.