What Is Working Capital? The Formula, Explained With a Real-Looking Example

Working capital is the money a business has available to run its day-to-day operations once it has set aside what it owes in the near term. It is the difference between the resources that will turn into cash within about a year and the bills that must be paid within about a year.

That sounds abstract, so this guide builds the number from scratch for a small, made-up homewares shop. By the end you should be able to pull the right lines off your own balance sheet, calculate working capital in a couple of minutes, and, more importantly, know what the result is telling you.

The working capital formula

Working capital = Current assets − Current liabilities

Both terms come straight from the balance sheet. "Current" is accounting shorthand for "expected to be used up, collected or paid within twelve months", or within one normal operating cycle if a business has a cycle longer than a year (a winery ageing stock, for example). Anything longer-lived, such as equipment, buildings, or the part of a loan due in three years, sits in the non-current sections and is left out.

A positive result means the business has more short-term resources than short-term obligations. A negative result means the opposite. Neither is automatically good or bad, which we come back to below, but the sign and the size give you a first read on how much breathing room there is.

What counts as a current asset or liability?

Most small-business balance sheets group these lines for you. If yours does not, these are the usual suspects:

Two lines trip people up. First, only the next twelve months of loan repayments count as current, even though the whole loan is a debt. Second, customer deposits are a liability: you have the cash, but you still owe the customer the product or service.

A worked example: Maple & Twine homewares

Maple & Twine is an imaginary two-person shop that sells candles, textiles and kitchenware in store and to a handful of cafés on 30-day invoices. At the end of its financial year its balance sheet shows:

Working capital is $72,000 minus $40,000, or $32,000. On paper, the shop has $32,000 more coming in over the next year from its existing short-term resources than it has going out to settle existing short-term bills.

Now look at the mix. More than half of the current assets ($40,000) is inventory. Candles and tea towels are not cash; they only become cash when someone buys them, and seasonal lines may need discounting first. If you strip inventory and the prepaid insurance out, the shop has $30,000 of cash and receivables against $40,000 of bills. That is why analysts rarely stop at the headline figure and move on to ratios such as the current ratio and quick ratio.

Gross, net and operating working capital

You will see a few variations of the term, and it helps to know which one someone means:

• Gross working capital is simply total current assets ($72,000 in the example). It is an older usage and not very informative on its own.
• Net working capital is current assets minus current liabilities. When people say "working capital" without a qualifier, this is almost always what they mean.
• Operating working capital (sometimes called non-cash working capital) strips out cash and interest-bearing debt to focus on the trading cycle: receivables plus inventory minus payables. For Maple & Twine that is $12,000 + $40,000 − $22,000 = $30,000. This version is popular in valuations and in business sale negotiations because it isolates the cash that is tied up simply by trading.

What the number can and cannot tell you

Working capital is a snapshot. It captures one day, usually a month-end or year-end, and businesses can look quite different a few weeks later. A retailer measured on 31 December, straight after the holidays, will show a lot of cash and little stock; the same shop in October will show the reverse.

It also treats every dollar of current assets as equal. A receivable from a reliable customer due next week and one that is 150 days overdue both count in full. Stock that sells every week and stock that has not moved since last spring both count at cost. Before relying on the figure, ask two quality questions: how much of the receivables would you genuinely expect to collect, and how much of the inventory would sell at close to its book value?

Finally, it says nothing about timing within the year. A business with healthy working capital can still hit a cash crunch in a particular week if a large supplier bill lands before customer payments arrive. That is why many owners pair it with a short-range 13-week cash flow forecast.

A quick routine for checking your own

• Pull the latest balance sheet from your accounting software and make sure the month has been fully reconciled.
• Add up current assets and current liabilities, and confirm the current portion of any loans is split out.
• Subtract to get working capital, then note how much of the assets are inventory and receivables.
• Look at the receivables aging report and discount anything very overdue in your head.
• Repeat monthly and watch the trend rather than any single reading.

Frequently asked questions