What is Working Capital?
Working capital is the difference between a company's current assets and current liabilities. It measures the cash available to fund day-to-day operations and short-term obligations.
Working capital = Current Assets − Current Liabilities. It reflects a company's ability to pay short-term debts and fund operations. Positive working capital is essential for business health.
- •Current assets exceed liabilities
- •Can pay bills on time
- •Fund growth opportunities
- •Absorb unexpected losses
- •Lower bankruptcy risk
- •Liabilities exceed assets
- •Liquidity concerns
- •Difficulty paying bills
- •May need external financing
- •Higher business risk
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Step-by-step worked examples
Company A has current assets of $500,000 and current liabilities of $300,000. What is its working capital?
WC = Current Assets − Current Liabilities WC = $500,000 − $300,000 = $200,000 Positive working capital of $200,000
A retailer's current assets: $120,000 cash, $180,000 inventory, $60,000 receivables. Current liabilities: $200,000. Calculate WC.
Current Assets = $120,000 + $180,000 + $60,000 = $360,000 Working Capital = $360,000 − $200,000 = $160,000 The business has sufficient liquidity
A startup spends $50,000 on inventory but hasn't received customer payments yet. Current assets $80,000, liabilities $120,000. WC?
Working Capital = $80,000 − $120,000 = −$40,000 Negative working capital; the startup needs external funding
Flashcards
Quick quiz
Q1.A company has $800,000 current assets and $500,000 current liabilities. Its working capital is:
Q2.Which is NOT a current asset?
Q3.A negative working capital means:
Q4.Which action increases working capital?
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Common mistakes
Confusing working capital with profit. — Correct: Profit measures earnings; WC measures liquidity. A profitable company can still have poor working capital.
Thinking all negative working capital is bad. — Correct: Some healthy businesses (e.g., Amazon) operate with negative WC through efficient cash management.
Ignoring inventory management. — Correct: Inventory is a major current asset; poor inventory turnover ties up working capital.
Neglecting accounts receivable collection. — Correct: Slow customer payments reduce working capital; tight credit policies improve it.
FAQ
What is working capital and why does it matter?
Working capital is current assets minus liabilities; it shows if a company can cover short-term obligations and fund operations.
Can a company have negative working capital and still be successful?
Yes. Companies with fast turnover (e.g., retail) can thrive with negative WC by collecting quickly and paying slowly.
How do you improve working capital?
Increase current assets (speed up collections) or reduce current liabilities (negotiate longer payment terms).
What's the difference between working capital and cash flow?
WC is a balance-sheet snapshot; cash flow is a time-series of cash in/out. Both matter for liquidity.