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How to Calculate Working Capital

Businesses looking to get a handle on their day-to-day spending and operations can learn a great deal from the concept of working capital. As a broad concept, working capital helps business owners understand their ability to meet their short-term obligations. Creditors and lenders will be particularly interested in it when evaluating your business. 

There are a few calculations that will allow you to analyze your working capital from a few angles. The first is done by calculating how much working capital you have as a dollar amount and the second by calculating your working capital as a ratio that can be calculated over time—presumably as your business grows. 

What is Working Capital? 

The concept of working capital helps you to understand your business’ ability to pay off short-term obligations like loan payments or accounts payable. But what does it mean literally? 

Working capital is defined as, “capital actively turned over in or available for use in the course of business activity.” In other words, it’s the money that changes hands (both incoming and outgoing) over the course of normal business operations. When you have a large amount of working capital, that means you’re bringing in more than you’re spending. 

Working capital relies on two concepts: current assets and current liabilities. 

Already familiar with working capital and its relationship to the current ratio? Try our our current ratio calculator here.

Working Capital Elements

Both current assets and current liabilities are numbers found on a business’ balance sheet. The balance sheet, as a reminder, is a snapshot a business—what it possesses, what it owes, and what it owns. 

Current assets and current liabilities fall on opposite sides of the balance sheet, which hinges on the equation: Assets = Liabilities + Equity. Here’s what these two sections mean specifically. 

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Current Assets 

On one side of the accounting equation is assets, or everything that a business possesses, whether or not they own it outright. For example, cash is considered an asset. But so is accounts receivable, or money that has not yet been received but is nevertheless claimed by a business as revenue. 

By the same token, larger items like a company van would be considered an asset, even if the business is still paying down a loan for it. 

Current assets include all assets that are expected to be converted to cash within one year. Accounts receivable is a perfect example of this, whereas a van (which will likely be used for several years) is a long-term asset. 

Current assets are all assets that are expected to be converted to cash within one year. 

Working capital shows all the money changing hands over the course of normal business, where current assets shows the incoming capital. 

Current Liabilities

Similar to current assets, current liabilities also carries a timestamp of one year. However, instead of showing what will bring cash into the business, it shows what a business will pay out over the coming year. 

Current liabilities can be short-term loans, accounts payable, dividends, or notes payable. Whatever obligation they represent, they will likely be paid off using current assets, which is why understanding your working capital is vital. 

Without enough in current assets, you will likely struggle to pay off current liabilities. 

Working Capital Formula

To calculate the total amount of working capital your business has, grab your most recent balance sheet and locate current assets and current liabilities. From there, simply subtract current liabilities from current assets. 

Working Capital = Current Assets – Current Liabilities 

Assuming you see a positive number, that means you’re in a pretty good position to pay off your current liabilities. But a simple dollar amount does not show the full picture, especially because changes in current assets or current liabilities can occur quickly. 

If sales drop one month, you may see a decrease in current assets. But if you’re still seeing a positive number, does it matter? 

The short answer is: Yes. 

A more valuable way of analyzing your working capital is to look at it as a ratio, comparing your current assets to current liabilities. Seeing these numbers in proportion to one another will allow you to compare your working capital to others in your industry more easily and will allow you to spot changes in working capital before they become problems. Lenders will also care more about seeing a ratio, too. 

Here’s how to calculate the working capital ratio—it may look familiar and is sometimes referred to as the Current Ratio. 

Working Capital Ratio = Current Assets / Current Liabilities 

We created a current ratio calculator where you can easily plug in your own current assets and liabilities from past balance sheets to find this ratio. 

If you have several past balance sheets handy, we recommend using the calculator to compare your working capital ratio over time. Has it remained consistent? Has it gone up or down? 

In all cases, you want to see a working capital ratio above one because this shows you’re in a strong position to pay off all current liabilities when they’re due. Calculating this ratio over time and comparing your numbers to industry averages will help you determine the buffer you want to keep for your business. 

An Example of Calculating Working Capital

For the fiscal year ending January 31, 2019, the video conferencing company Zoom (ZM) had $276,719,000 in current assets. They also had $152,341,000 in current liabilities. 

This means that, at the end of the year, they had $124,378,000 total in working capital. 

Their working capital ratio was 1.82. 

$276,719,000 / $152,341,000 = 1.82 

With a ratio of 1.82, Zoom found themselves in a strong position to pay off all current liabilities. While we may not know the industry expectations, we do know that they are not in immediate danger of not meeting their obligations.

For more information about working capital and the current ratio, try out the calculator tool and learn more about applying the current ratio to your business. 

Ready to talk to a ScaleFactor expert about how we can help you take control of your finances? Schedule a demo today.

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