Working Capital
$$\text{Working Capital} = \text{Current Assets} - \text{Current Liabilities}$$
What is Working Capital?
Working Capital is the difference between a company's current assets (cash, accounts receivable, inventory) and current liabilities (accounts payable, accrued expenses, short-term debt). It measures a company's short-term liquidity — the net financial resources available to fund the next 12 months of operations.
Positive Working Capital means a company has more short-term assets than short-term obligations — generally a sign of financial health. Negative Working Capital (more liabilities than current assets) can signal liquidity stress, but it is actually the norm in some business models: retailers like supermarkets collect cash from customers immediately while paying suppliers on 30–60 day terms, generating negative Working Capital as a structural feature.
Changes in Working Capital affect operating cash flow. If accounts receivable grows faster than revenue (customers paying more slowly), Working Capital consumes cash. If accounts payable grows (suppliers extending terms), Working Capital releases cash. This is why a company can have positive net income but negative operating cash flow if Working Capital is building up.
When to use Working Capital
Monitor Working Capital trends to assess liquidity and cash conversion efficiency. Use the Cash Conversion Cycle (Days Sales Outstanding + Days Inventory Outstanding − Days Payables Outstanding) for a more granular view. In M&A, analyse Working Capital normalisation — the target Working Capital level that a buyer would expect at closing.
Worked examples
| Current Asset / Liability | Typical range (% of revenue) | What it signals |
|---|---|---|
| Cash & equivalents | 5% – 20% | Liquidity buffer |
| Accounts receivable (DSO) | 30 – 60 days | Billing and collection efficiency |
| Inventory (DIO) | 30 – 90 days | Supply chain and demand forecasting |
| Accounts payable (DPO) | 30 – 60 days | Supplier payment terms |
Common pitfalls
Working Capital requirements can change rapidly as a business grows. A company that doubles revenue without equivalent Working Capital financing may face a cash crisis even if it is profitable. Always model Working Capital needs as part of a growth plan and ensure adequate facilities (e.g. revolving credit facilities) to fund peak requirements.
Frequently asked questions
Can a company be profitable and still run out of cash?
Yes. If a company collects revenue slowly (long DSO) but grows rapidly, Working Capital investment will consume cash even if the income statement shows a profit. This is called a Working Capital trap and is a common cause of cash crises in fast-growing businesses.
Is negative Working Capital always bad?
No. Negative Working Capital can be structurally positive in businesses that collect cash before paying suppliers — subscription businesses, retailers, and fast-food chains. Amazon, for example, runs negative Working Capital as a feature of its model, not a flaw.
What is the difference between Working Capital and Cash?
Cash is a component of Working Capital (a current asset). Working Capital is the broader concept: Current Assets − Current Liabilities, including receivables, inventory, payables, and accruals, not just cash. A company can have positive Working Capital but very little cash if most of the current assets are tied up in slow-moving inventory.