What is working capital and how to calculate it

Working capital is the money a business has available to fund its day-to-day operations, calculated as current assets minus current liabilities. It tells you whether a company can cover its short-term obligations with the assets it can quickly turn into cash. Positive working capital means you can; negative working capital means you may be relying on financing or new sales to keep the lights on.

It is one of the clearest measures of short-term financial health. Profit shows up on the income statement, but a profitable company can still run short of cash if too much of its money is locked in unpaid invoices and inventory. Working capital is where that tension shows.

What is working capital

Working capital is the cushion between what you own that will become cash soon and what you owe that will come due soon. Both sides are current, meaning they resolve within the normal operating cycle, usually a year.

• Current assets: cash, accounts receivable, inventory, and short-term investments.
• Current liabilities: accounts payable, short-term debt, accrued expenses, and the current portion of long-term debt.

The difference is your working capital. It funds payroll, supplier payments, and the gap between paying for inputs and collecting from customers. Run it too thin and you risk missing obligations; let it bloat and you have cash sitting idle that could be invested or returned.

Working capital formula

Working Capital = Current Assets - Current Liabilities

For a relative measure, finance teams also use the working capital ratio, which scales the figure to the size of the obligations:

Working Capital Ratio = Current Assets / Current Liabilities

The dollar figure tells you the absolute buffer. The ratio tells you how many times over your current assets cover your current liabilities, which lets you compare companies of different sizes.

Worked example

Suppose a company has the following on its balance sheet:

• Cash: 120,000
• Accounts receivable: 380,000
• Inventory: 200,000
• Current assets: 700,000
• Accounts payable: 250,000
• Short-term debt: 100,000
• Accrued expenses: 50,000
• Current liabilities: 400,000

Working Capital = 700,000 - 400,000 = 300,000

Working Capital Ratio = 700,000 / 400,000 = 1.75

A working capital of 300,000 and a ratio of 1.75 is a healthy position. Notice that accounts receivable, at 380,000, is the single largest current asset, more than half the total. That detail matters: most of this company's working capital is not cash, it is invoices waiting to be collected.

What is a good working capital ratio

A working capital ratio between 1.5 and 2.0 is generally considered healthy. It means current assets comfortably cover current liabilities with room to spare.

• Below 1.0: current liabilities exceed current assets. The company may struggle to meet short-term obligations and could face a liquidity squeeze.
• 1.0 to 1.5: workable but tight, with little buffer for a bad month.
• 1.5 to 2.0: the comfortable range for most businesses.
• Above 2.0: often a sign that cash, receivables, or inventory are sitting idle rather than being put to work.

The right number varies by industry. A business that collects cash fast and turns inventory quickly can run leaner than one with long sales cycles. As with most metrics, the trend matters more than the absolute: a ratio drifting down month over month signals a problem before it becomes a crisis.

How AR affects working capital

Accounts receivable is usually one of the largest components of current assets, which makes it one of the biggest drivers of working capital. But it is a double-edged figure. A high receivables balance lifts working capital on paper, while in reality it represents cash you have earned and not yet collected, money locked up rather than available.

This is the gap between book working capital and usable cash. An invoice sitting in your aging report counts as a current asset, but you cannot use it to make payroll until it is collected. The longer it ages, the less certain that collection becomes, and the more of your working capital is effectively frozen.

That is why receivables are the most direct lever on working capital that a finance team controls. You cannot will customers to pay, but you can shorten the time between invoice and cash by following up consistently, resolving disputes quickly, and applying payments cleanly.

How to improve working capital

The textbook levers are: collect receivables faster, manage inventory tighter, and time payables sensibly. Of these, collections is the one you control most directly and the one that frees the most cash with the least friction.

The math is simple. Every day you shave off the average time to collect converts a slice of receivables into spendable cash. A company carrying 380,000 in receivables that collects in 45 days instead of 60 frees up roughly a quarter of that balance in working capital, without taking on a dollar of debt or renegotiating a single supplier term.

The catch is that doing this well across a full ledger is relentless work: chasing the right accounts at the right time, investigating short payments and disputes, and applying cash the moment it lands. That is exactly the work Rex does autonomously. It runs collections continuously, resolves the disputes and deductions that keep cash trapped, applies incoming payments cleanly, and escalates only the accounts that need a person, all measured on cash recovered and days outstanding. The result is working capital that lives in your bank account instead of your aging report.

See how Rex frees up the cash trapped in your receivables.