The financial health of a business depends on more than just revenue. A business can be profitable on paper and still struggle to make payroll the next month. It can hit its revenue targets but miss out on a major opportunity because cash was tied up in inventory or receivables.

Working capital is the difference between your business' short-term obligations and the resources you have on hand to meet them. It's one of the clearest indicators of how much leeway your business has for operations and growth. A 2024 survey found that 62% of growth corporate CFOs and treasurers had been using external working capital solutions to drive growth and achieve operational efficiencies.

Below, we'll explain how to calculate working capital, why it matters and how to strengthen it.

What's in this article?

• What is working capital?
  
• What are the benefits of strong working capital?
  
• How do you calculate your working capital ratio?
  
• How can you improve your working capital ratio?
  

What is working capital?

Working capital is the money a business has available to cover its short-term financial obligations after subtracting what it owes from what it owns in the near term.

Here's the basic formula:

Working Capital = Current Assets - Current Liabilities

Current assets are anything you expect to convert to cash within a year, including:

• Cash and cash equivalents
  
• Accounts receivable
  
• Inventory
  

Current liabilities are obligations due within a year, including:

• Accounts payable
  
• Accrued expenses
  
• Short-term loans
  
• Taxes payable
  

The difference between the two is your net working capital. This number gives you a real-time view of your ability to fund day-to-day operations. If it's positive, you have more liquid assets than near-term debts. That means you can pay your bills, manage costs and still have some cash left over. If it's negative, liabilities are outpacing available resources, which might signal a risk of cash shortfalls or payment delays.

A seasonal peak in sales, a new inventory investment, or a slowdown in customer payments can increase or decrease your working capital. That's why businesses monitor it continually to track short-term solvency and financial flexibility. It's the difference between having to scramble for cash and being able to act on opportunity.

Sample calculation

Assume a company has these current assets:

• £50,000 in cash
  
• £100,000 in accounts receivable
  
• £75,000 in inventory
  

And assume it has these current liabilities:

• £80,000 in accounts payable
  
• £50,000 in short-term loans and accrued expenses
  

Working Capital = £225,000 (Assets) - £130,000 (Liabilities) = £95,000

Working capital is what's left over after the business settles its short-term obligations. It's what the company has to work with, whether to buy more inventory, cover seasonal slowdowns or fund its next project.

Positive working capital is generally a good sign: it means the company can handle its bills and still have breathing room. It might even be able to grow without needing extra financing.

But if the numbers were reversed – if assets were £130,000 and liabilities were £225,000 – working capital would be£95,000. That's negative working capital, which signals that the business doesn't have enough current resources to cover what it owes. That might be temporary, or it might point to a deeper liquidity issue that needs solving.

Context matters. Some fast-moving businesses can run leanly without problems, while others need a bigger buffer to function.

What are the benefits of strong working capital?

Strong working capital can allow your business to move, adjust and grow without worrying about timing. Here's what that kind of flexibility enables:

• Operating with less stress: When your working capital is solid, you can cover payroll, pay suppliers and handle day-to-day expenses without stress. You won't have to wait for one big payment before you write cheques or juggle due dates to buy time.
  
• Handling surprises: Any business can experience a delayed customer payment, surprise repair or slower quarter. Strong working capital gives you the leeway to absorb these unexpected costs without turning to short-term debt or emergency cuts.
  
• Saying yes faster: When you have working capital to spare, you can say yes to new opportunities – for instance, a vendor that offers a bulk discount, a customer who makes a big order, or the chance to invest in a new product – without pausing to consider whether you can afford it.
  
• Looking better to lenders and investors: Positive working capital signals reliability. It shows you're managing liquidity intentionally, which goes a long way with banks, investors and partners. They want to know whether you can deliver what you've promised, even if conditions shift.
  
• Expanding on your own timeline: Strong working capital means you don't have to take on financing every time you want to grow. You can reinvest your own cash into your next venture on your terms, at your pace. And when you do need outside capital, your numbers make the case easier.
  

How do you calculate your working capital ratio?

The working capital ratio – also known as the current ratio – shows how well your short-term assets stack up against your short-term debts.

Here's the basic formula:

Working Capital Ratio = Current Assets ÷ Current Liabilities

This ratio divides assets by liabilities to give you a relative measure, not an absolute number. Working capital tells you how much you have, while the working capital ratio tells you how well you're covered.

Consider the previous example of a business with £225,000 in current assets and £130,000 in current liabilities. Divide the former figure by the latter, and you get a ratio of about 1.73. That means you have £1.73 in assets for every £1.00 you owe in the short term.

A good working capital ratio falls somewhere between 1.50 and 2.00. If the ratio is too low, you risk not being able to cover your bills or other costs. If the ratio is too high, you might not be using your working capital as efficiently as you could be (e.g. by letting cash or inventory sit instead of using it thoughtfully).

That said, what counts as a "healthy" ratio varies by industry. Some businesses run leanly by design. Others, especially those with long sales cycles or heavy inventory needs, need more room to manoeuvre.

How can you improve your working capital ratio?

Improving your working capital ratio means strengthening your ability to cover short-term obligations without putting pressure on cash flow. You can do that by increasing your current assets, reducing your current liabilities, or both.

Here are some practical ways you can increase your ratio.

Speed up receivables

The faster you get paid, the stronger your working capital becomes.

To speed up receivables, you can:

• Invoice immediately
  
• Follow up early and consistently
  
• Offer small discounts for early payment, if they make sense
  
• Tighten credit terms for slow-paying customers
  

Keep inventory lean

Holding inventory often means tying up cash. Too much inventory, especially if it isn't moving, can quietly decrease your working capital.

To keep inventory lean, you can:

• Track turnover rates and cut what's not selling
  
• Reorder more frequently in smaller batches
  
• Avoid buying ahead of demand unless there's a clear upside
  

Well-managed inventory turns into revenue faster and frees up capital for other parts of the business.

Rethink payables

You don't want to delay payments and damage supplier relationships. But you also don't need to pay every invoice immediately.

To match inflows with outflows more strategically, you might:

• Negotiate longer payment terms when you can
  
• Time payments closer to due dates without missing them
  
• Build strong vendor relationships that give you room to manoeuvre
  

Cut unnecessary short-term debt

Too much short-term borrowing can decrease your ratio. If you can reduce or restructure it, that makes a difference.

Consider:

• Refinancing short-term loans into longer-term ones where appropriate
  
• Staying away from credit lines for expenses that don't generate quick returns
  
• Being thoughtful about what gets paid off first
  

Reducing current liabilities helps manage the shape and timing of your obligations.

Build a cash buffer

Having extra cash on hand improves your ratio by increasing current assets and gives you more options when surprises occur.

To build this buffer, you can:

• Set aside a percentage of revenue as a reserve
  
• Hold on to some retained earnings rather than distributing all profits
  
• Use equity or long-term financing (rather than short-term borrowing) to fund growth when possible
  

Even a modest buffer can protect your working capital ratio during slow periods or when surprise expenses appear.