7 min read
What Is Working Capital? Formula, Ratio & How to Calculate It
By Christopher Chavez, Founder — Northwood Capital Group
Every small business owner has felt it: payroll is Friday, a big invoice is 30 days out, and the checking account is lighter than you'd like. That gap is exactly what working capital measures. It's not profit, revenue or total cash — it's the liquid money available to run the business day to day.
Understanding working capital helps you spot trouble before it arrives, decide whether to take on new work, and know when a short-term financing tool is the right move. This guide breaks down the formula, the ratio, net working capital, and what the numbers actually mean.
What is working capital?
Working capital is the difference between your current assets and your current liabilities. In plain English: it's the cash and near-cash you have to cover bills that are due within the next year.
- Current assets — cash, accounts receivable, inventory, prepaid expenses, short-term investments.
- Current liabilities — accounts payable, short-term loans, credit card balances, payroll taxes, accrued expenses.
When current assets are larger than current liabilities, the business has positive working capital. When liabilities are larger, working capital is negative.
The working capital formula
The formula is simple, but the inputs matter:
Working Capital = Current Assets − Current Liabilities
For example, if your business has $180,000 in current assets and $120,000 in current liabilities, your working capital is $60,000. That means you have $60,000 of cushion to absorb slow payments, unexpected costs or growth investments.
Current assets vs. current liabilities
| Current assets | Current liabilities |
|---|---|
| Cash in checking/savings | Accounts payable |
| Accounts receivable | Short-term loans or lines of credit |
| Inventory | Credit card balances |
| Prepaid expenses | Payroll taxes owed |
| Short-term investments | Accrued expenses |
| Supplies and raw materials | Current portion of long-term debt |
Net working capital
Net working capital is the same calculation with a different name. Accountants and lenders often use "net" to stress that the number is what's left after short-term debts are subtracted. The formula is identical:
Net Working Capital = Current Assets − Current Liabilities
On a balance sheet, you'll sometimes see this called "NWC." For small business lending, NWC is one of the first numbers an underwriter checks because it shows whether the business can handle its near-term obligations without relying on new financing.
The working capital ratio
The working capital ratio (also called the current ratio) adds context that the dollar figure alone can't show. It compares the size of current assets to current liabilities:
Working Capital Ratio = Current Assets ÷ Current Liabilities
Using the same example: $180,000 ÷ $120,000 = 1.5. That means the business has $1.50 in current assets for every $1.00 in current liabilities.
- Ratio above 2.0 — usually very safe, but may also mean cash is idle and not working hard enough.
- Ratio 1.2 to 2.0 — the healthy range for most small businesses.
- Ratio 1.0 to 1.2 — tight; any unexpected expense or late payment can create stress.
- Ratio below 1.0 — current liabilities exceed current assets; the business may need financing or operational changes quickly.
What your working capital number means
A positive number is good, but context matters. A seasonal contractor may run low working capital in the off-season by design. A SaaS company may collect annual subscriptions up front, creating temporarily high working capital.
For most product, service and construction businesses, the key signal is trend. If working capital has been shrinking for three quarters, it's a warning even if the current number is still positive.
How to calculate working capital step by step
- Pull your balance sheet. Use the most recent month-end or quarter-end statement.
- Add current assets. Include only items that convert to cash within 12 months.
- Add current liabilities. Include only obligations due within 12 months.
- Subtract. Current assets minus current liabilities equals working capital.
- Divide for the ratio. Current assets divided by current liabilities gives you the working capital ratio.
How to improve working capital
Before borrowing, most businesses can improve working capital through operations:
- Collect receivables faster. Invoice immediately, offer small early-pay discounts, and follow up before due dates.
- Negotiate supplier terms. Even an extra 15 days on payables can free up meaningful cash.
- Right-size inventory. Excess inventory ties up cash that could pay bills or fund growth.
- Use a line of credit as a bridge. A revolving line is designed exactly for short-term working capital gaps, not long-term projects.
When working capital financing makes sense
Operational fixes take time. When a growth opportunity, slow season, or large receivable creates a temporary gap, a working capital loan or line of credit can keep the business moving. The right product depends on speed, cost and how long you need the capital.
See our full guide to working capital loans for small business to compare lines of credit, short-term loans, MCAs and SBA options. Or explore Northwood's working capital programs directly.
Get a working capital quote
Northwood Capital Group funds working capital lines, short-term loans, SBA products and revenue-based advances from $25,000 to $5 million. Most files receive a decision in 24–48 hours with no impact to personal credit at the pre-qualification stage.
Start on the apply page, or call (714) 679-8886 to talk through your working capital needs.