Working Capital Formula
If the working capital formula fills you with dread, read on.
The working capital formula provides an important insight into the financial health of a business in the short term. It is a simple calculation of the difference between short term assets and current liabilities, and shows how much money is left over for day to day operations.
If your working capital formula calculation reveals a business balance sheet with negative working capital – there are things you can do. Prospa is a specialist business lender that supports NZ small businesses with small business loans of up to $500,000 to cover short term financial shortfalls.
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Working capital is a business essential
In New Zealand, many small businesses struggle to maintain a positive working capital balance 100% of the time – especially if the business is seasonal. Without a healthy cash flow, a business will struggle to operate efficiently – because working capital is the cash required for the day to day operations of a business.
You need working capital for:
Paying staff wages
Covering invoice gaps
Marketing or promotions
Paying tax bills
Here’s how one customer used business finance to support growth
When Kurt Jacks wanted funds to upgrade and renovate his southern style ribs restaurant in Pakuranga, Auckland, he turned to Prospa. The Rib House owner soon realised a Prospa Small Business Loan was precisely what he needed to take his restaurant to the next level.
See Kurt’s story here.
Some FAQs about working capital formula
How do you calculate working capital?
Working capital is calculated using the working capital ratio. It is the current assets divided by current liabilities. Calculations greater than 1 reveal positive working capital, less than 1 reveal negative working capital. A higher ratio means more cash flow or working capital.
What are the 4 main components of working capital?
Working capital is broadly comprised of current assets and current liabilities. Current assets are those which a business can readily convert into cash within the space of a year. Current assets can be broken down into three areas: cash, bank balances and short term financial investments; accounts receivable; and inventory. Current liabilities are general day to day expenses – like accounts payable, rent, utilities, tax bills, short term loan repayments, etc.
Long term fixed assets or investments, such as real estate, collectibles and market securities, should not be included in your working capital formula.
What is a good working capital ratio?
When you use the working capital formula, a ratio of 1.5 or 2 provides a comfortable buffer for a business owner to manage day to day operations. Anything higher than 2 is ok, but a figure like that could indicate the business may benefit from reinvesting some of the working capital back into the business for growth.
Is cash included in working capital?
Yes, working capital should include cash and any funds in the bank. It should also include any short term liquid assets or investments; accounts receivable; and inventory. Current or short term liabilities are general day to day expenses – like accounts payable, rent, utilities, tax bills, short term loan repayments, or other debt etc.
Long term assets or investments, such as real estate, large amounts of collectibles and market securities, should not be included in a working capital calculation.