More control and less work. Even in your industry.
Fast and secure invoice processing for every organization.
Fast and secure invoice processing for every organization
Working capital is the financial breathing room your business needs to operate smoothly. But what is a good working capital ratio, and how does it affect your financial health? In this article, we explain the definition of working capital, how to calculate it, what a strong or weak ratio looks like, and how to improve it with effective strategies.
Table of contents:
Working capital represents the difference between your current assets (such as inventory, accounts receivable, and cash) and your current liabilities (such as short-term debts, accounts payable, and taxes). In simple terms, it’s the cash available to cover your day-to-day operations.
The formula is: Working capital = current assets – current liabilities
A positive figure suggests your business can cover its short-term obligations. A negative working capital, on the other hand, may signal liquidity problems or cash flow risk. This makes understanding the importance of working capital management crucial for any business aiming for sustainable growth.
A good working capital ratio typically falls between 1.2 and 2.0. This means your company has $ 1.20 to $ 2.00 in current assets for every $ 1.00 in current liabilities. A ratio below 1.0 indicates negative working capital, while a ratio above 2.0 might suggest underutilized assets.
Knowing what is a good working capital ratio helps you assess whether your company is running efficiently. It also supports strategic decisions around investing, hiring, and expanding. Compared to metrics like the current ratio vs working capital, the working capital ratio provides a practical snapshot of your liquidity position.
To gain deeper insights, businesses often look at calculating net working capital using adjusted figures that exclude inventory or less liquid assets. Another key metric is the working capital to revenue ratio, which shows how much working capital is required to generate revenue.
When reviewing the change in net working capital formula, you track changes over time to understand how your liquidity position is evolving. A consistent decline might indicate growing financial strain.
Operating working capital excludes cash and short-term debt, focusing purely on the operational elements like receivables, payables, and inventory. It’s a more accurate measure of how well you manage your operations.
The working capital turnover ratio indicates how efficiently your business uses its working capital to support sales. A higher turnover means you’re generating more revenue per dollar of working capital, which is generally a sign of operational efficiency.
If you’re managing working capital for optimal financial health, consider these practical strategies:
These working capital strategies not only improve liquidity but also help reduce dependency on external financing.
Managing receivables is one of the biggest opportunities to free up working capital. With Payt, you can automate your entire accounts receivable process while maintaining personal communication with clients.
With Payt:
While your accounting shows the current status of your working capital, Payt actively improves it. Would you like to know more? Download our brochure or schedule a demo.
Gross working capital includes all current assets. Net working capital subtracts current liabilities from those assets.
It’s the use of external resources like business loans or factoring to supplement your working capital.
By getting paid faster, reducing inventory, and renegotiating supplier terms. Automation software can help drive these changes.
