What is the Working Capital Formula?
The working capital formula is:
Working capital = Current Assets – Current Liabilities
The working capital formula tells us the short-term, liquid assets remaining after short-term liabilities have been paid off. It is a measure of a company’s short-term liquidity and important for performing financial analysis, financial modeling, and managing cash flow.
Below is an example balance sheet used to calculate working capital.
Example calculation with the working capital formula
As an example, a company can increase its working capital by selling more of its products. If the price per unit of the product is $1000 and cost per unit in inventory is $600, the company’s working capital will increase by $400 for every unit, because either cash or accounts receivable will increase.
Comparing the working capital of a company against its competitors in the same industry can demonstrate its competitive position. If Company A has working capital of $40,000 while Companies B and C have $15,000 and $10,000, respectively, Company A can spend more money to grow its business faster than its competitors.
What is working capital?
Working capital is the difference between a company’s current assets and current liabilities. It is a financial measure, which calculates whether a company has enough liquid assets to pay its bills that will be due in a year. When a company has excess current assets, that amount can then be used to spend on its day-to-day operations.
Current assets, such as cash and equivalents, inventory, accounts receivable and marketable securities, are resources a company owns that can be used up or converted into cash within a year.
Current liabilities are the amount of money a company owes such as accounts payable, short-term loans and accrued expenses, which are due for payment within a year.
Positive vs negative working capital
Having positive working capital can be a good sign of the short-term financial health for a company because it has enough liquid assets remaining to pay off short-term bills and to internally finance the growth of their business. Without additional working capital, a company may have to borrow additional funds from a bank or turn to investment bankers to raise more money.
Negative working capital means assets aren’t being used effectively, and a company may a liquidity crisis. Even if a company has lots invested in fixed assets, it will face financial challenges if liabilities come due too soon. This will lead to more borrowing, late payments to creditors and suppliers and, as a result, a lower corporate credit rating for the company.
When negative working capital is ok
Depending on the type of business, companies can have negative working capital and still do well. Examples are grocery stores like Walmart or fast-food chains like McDonald’s that can generate cash very quickly due to high inventory turnover rates and by receiving payment from customers in a matter of a few days. These companies need little working capital.
Products that are bought from suppliers are immediately sold to customers before the company even gets a chance to pays the vendor or supplier. In contrast, capital-intensive companies that manufacture heavy equipment and machinery usually can’t raise cash quickly, as they sell their products on a long-term payment basis. Since they can’t sell fast enough, cash won’t be available immediately during tough financial times, so having enough working capital is desirable.
Learn more about a company’s Working Capital Cycle, and the timing of when cash comes in and out of the business.
Adjustments to the working capital formula
While the above formula and example are the most standard definition of working capital, there are other more focused definitions.
Examples of alternative formulas:
- Current Assets – Cash – Current Liabilities (excludes cash)
- Accounts Receivable + Inventory – Accounts Payable (this represents only the “core” accounts that make up working capital in day-to-day operations of the business)
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Working capital in financial modeling
We hope this guide on the working capital formula has been helpful. If you’d like more detail on how to calculate working capital in a financial model, please see our additional resources below.