What Is Working Capital and How Do You Calculate It?
Working capital is your current assets minus your current liabilities: what your business owns that will turn into cash within a year, less what it owes within a year. Positive working capital means you can cover your short-term bills. Negative means you're relying on future sales to pay them.
What Working Capital Means
Working capital is the money a business has available to run day to day: to pay suppliers, wages and the IRD while it waits for customers to pay. It isn't the same as the bank balance. A business can have plenty of working capital on paper but little cash, if most of it is sitting in unpaid invoices or stock.
That's why working capital and the cash conversion cycle are usually read together. Working capital tells you how much is tied up; the cycle tells you for how long.
The Formula
Working Capital = Current Assets − Current Liabilities
| Current assets (turn into cash within 12 months) | Current liabilities (due within 12 months) |
|---|---|
| Cash in the bank | Accounts payable (supplier invoices) |
| Accounts receivable (customer invoices) | GST, PAYE and income tax owing |
| Inventory (stock on hand) | Overdraft and credit card balances |
| Prepayments | Loan repayments due in the next 12 months |
A related number is the current ratio: current assets divided by current liabilities. A ratio of 1.5 means you have $1.50 of short-term assets for every $1 of short-term debts. Many accountants look for something between about 1.2 and 2 for a business that holds stock, but the right level depends on your industry and how quickly your stock and invoices turn into cash.
In Xero, both totals are on the Balance Sheet report, under Current Assets and Current Liabilities.
Worked Example
Example (illustrative figures): a Palmerston North wholesale distributor's balance sheet at 30 September shows:
| Current assets | Current liabilities | ||
|---|---|---|---|
| Bank | $40,000 | Accounts payable | $120,000 |
| Accounts receivable | $185,000 | GST and PAYE owing | $35,000 |
| Inventory | $150,000 | Loan repayments due this year | $45,000 |
| Total | $375,000 | Total | $200,000 |
Working capital = $375,000 − $200,000 = $175,000. Current ratio = $375,000 ÷ $200,000 = 1.9.
That looks healthy, but only $40,000 of it is cash. If $60,000 of the receivables are more than 60 days overdue, the business could still struggle to pay its suppliers on the 20th, despite a strong-looking number.
What a Negative Number Means
Negative working capital means your business owes more in the next 12 months than it holds in cash, receivables and stock. For most small businesses that sell on account, it's a warning sign: bills are being paid from next month's sales, and one slow-paying customer can cause a shortfall.
There are exceptions. Businesses paid upfront by customers but on terms by their suppliers, such as supermarkets or some retailers, can run on negative working capital by design. A wholesaler selling on 30-day terms usually can't.
Five Ways to Improve It
- Collect faster. Every day you cut from your debtor days turns a receivable into cash sooner.
- Pay suppliers on their terms, not early. Keep your creditor days in line with what suppliers have agreed to, without stretching past it.
- Carry less stock. Clear slow lines and order fast sellers more often.
- Move short-term debt to a term loan if an overdraft is funding long-term assets like vehicles or equipment.
- Get paid upfront on large invoices. When a customer pays in instalments through a provider that pays you in full upfront, the invoice turns into cash on day one instead of sitting in receivables.
For how these fit together across the business, see the Cash Flow guide.
Frequently Asked Questions
Is working capital the same as cash flow?
No. Working capital is a snapshot of short term assets and debts at one date. Cash flow is the movement of money in and out over a period. A business can have positive working capital and still have a cash flow problem if its assets are tied up in stock or unpaid invoices.
How much working capital does a small business need?
Enough to cover your regular outgoings while you wait to be paid. A practical starting point is your cash conversion cycle in days multiplied by your daily cost of sales, plus a buffer for wages, tax and the occasional late payer.
Is net working capital different from working capital?
Usually they mean the same thing: current assets minus current liabilities. Some analysts leave cash and debt out of net working capital to focus on stock, receivables and payables, so check which version is being used before comparing figures.
Why does working capital drop when sales grow?
More sales mean more stock to buy and more invoices waiting to be paid, and those are funded from cash before the customer pays. Fast growth can therefore drain cash even when every sale is profitable.
What is a working capital loan?
A short term loan or overdraft used to cover everyday costs while you wait for customers to pay. It helps bridge a gap but adds interest, so it works best alongside faster collection rather than instead of it.
