What Is Working Capital? The Formula, a Worked Example and the Ratio Lenders Look At

Xero describes it as a measure of whether a business has enough short-term resources to cover what it owes over the next 12 months. It's one of the first figures an accountant or a lender will look at, and it's one of the easiest to work out yourself.

What counts as a current asset and a current liability

Current means due, or able to turn into cash, within 12 months. These are the items Xero lists on each side:

Current assets	Current liabilities
Cash and bank balances	Accounts payable (what you owe suppliers)
Accounts receivable (what customers owe you)	Short-term loans or lines of credit
Inventory	Taxes owed
Prepaid expenses such as rent or insurance	Wages due
Short-term investments	Accrued expenses

The working capital formula, with Xero's florist example

The formula is: working capital = current assets minus current liabilities. Xero uses a florist to show it. The shop has $100,000 in current assets and $75,000 in current liabilities, so its working capital is $25,000 (Xero's figures, as of October 2026).

Item	Florist example (Xero, as of October 2026)
Current assets	$100,000
Current liabilities	$75,000
Working capital	$25,000
Working capital ratio	1.33
Net working capital (operating items only)	$80,000 minus $65,000 = $15,000

The working capital ratio and the range Xero calls healthy

Divide instead of subtracting and you get the working capital ratio, also called the current ratio. For the florist, $100,000 divided by $75,000 gives 1.33. Xero says most lenders and financial advisors consider 1.2 to 2.0 healthy for a small business. Below 1.0 suggests you may struggle to meet short-term obligations. Above 2.0 may mean assets are sitting there that could be put to work. Treat that range as Xero's guide, not a rule.

Negative working capital is usually a warning sign for a small business, and Xero links it to late payments, strained supplier relationships and trouble covering payroll. It isn't always bad, though. Xero and Corporate Finance Institute both point out that some industries, such as grocery retail, run that way because customers pay up front and suppliers give 30 days or more of credit.

Net working capital: the operating version

You'll also see the term net working capital. Xero says it's closely related and often used interchangeably, but in practice it usually leaves out cash and debt and looks only at operating assets and liabilities. In Xero's example, $80,000 of operating current assets minus $65,000 of operating current liabilities gives $15,000 (as of October 2026). It shows what your day-to-day trading ties up.

Why a profitable business can still run short of cash

This is the bit most owners miss. Working capital is a snapshot of one date. Cash flow tracks cash moving in and out over a period. Xero says you can have positive working capital and still face a cash problem if it's tied up in unpaid invoices or unsold inventory, while a business with tight working capital can have strong cash flow if cash moves through quickly.

Stripe makes the same point from the other side: a business can look profitable and still have limited working capital, because its assets are sitting in stock nobody's bought yet or invoices nobody's paid. Profit tells you the model works. Working capital tells you whether the business can keep operating while it does. Stripe names the situations where that gap matters more than profit:

• Fast growth, where cash comes in later than it goes out
• Seasonal revenue with costs that run all year
• Startups investing ahead of revenue
• Supply chain delays or a sudden expense

Corporate Finance Institute warns growing firms about the first one in particular: growth itself can drain the cash a company needs to keep going. And for service businesses such as consultants, agencies and accountants, Xero notes there's little inventory to worry about. The pressure point is how fast clients pay, and slow payers can create a shortfall even when the business is profitable.

The working capital cycle, counted in days

Corporate Finance Institute measures how long cash is tied up with a simple sum: inventory days plus receivable days minus payable days. In its example, 85 days of inventory plus 20 days to get paid minus 90 days to pay suppliers leaves the company 15 days out of pocket before it's paid in full. If the same company only took cash at the till, receivable days drop to zero, and 85 plus 0 minus 90 gives minus 5: customers pay 5 days before the suppliers need paying.

CFI adds that banks may lend against inventory, or finance receivables through factoring, to bridge that gap.

People who read this usually go on to the plain-English take on petty cash.

How to work out yours, step by step

1. Add up your current assets: cash, what customers owe you, inventory and prepaid items.
2. Add up your current liabilities: supplier bills, short-term loans, and tax and wages due.
3. Subtract liabilities from assets for the amount, and divide assets by liabilities for the ratio.
4. Check the result against the invoices due in and the bills due out over your next 30 to 90 days.
5. If it's thin, chase invoices and renegotiate supplier terms before you borrow.

My cash flow forecast template makes step four much easier, because it shows the timing that a single working capital figure hides.

How to improve working capital before you borrow

Xero and Stripe list the same practical levers: manage inventory so less cash sits on shelves, speed up customer payments with reminders or early payment incentives, negotiate longer supplier terms, keep expenses under control and monitor cash flow with short-term projections. Good invoicing software helps with the second one, and I've compared invoicing tools for freelancers and small businesses if yours is slowing you down.

Financing comes last, not first. Xero lists working capital loans (typically repaid within 12 months), lines of credit and invoice financing, and says borrowing should be a last resort after you've fixed the operational side. If you do get there, my guide to alternatives to a standard bank loan covers the options.

My verdict

Working capital is a useful number, but it's a photo, not a film. Read it next to your cash flow, never on its own. If you run a service business, the biggest lever you've got isn't a loan or a cheaper supplier, it's how fast your clients pay you. In 23 years in marketing I've learned that a full order book doesn't pay the bills; paid invoices do. So send invoices the day the work's done, chase them the day they fall due, and you'll rarely need to worry about the ratio.

If you want the plain-English version, my explainer on revenue has it.

Frequently asked questions

What is working capital in simple terms?

It's current assets minus current liabilities: the cash and near-cash a business has, less the bills due in the next 12 months.

What is a good working capital ratio?

Xero says most lenders and financial advisors consider 1.2 to 2.0 healthy for small businesses, and below 1.0 suggests trouble meeting short-term obligations. It's a guide, not a rule.

Is working capital the same as cash flow?

No. Working capital is a snapshot of one date, while cash flow tracks cash moving over a period. You can have positive working capital and still run short of cash.

Can working capital be negative?

Yes. It's usually a warning sign for a small business, but some industries such as grocery retail run that way because customers pay up front and suppliers give credit.

What's the difference between working capital and net working capital?

Xero says they're often used interchangeably, but net working capital usually leaves out cash and debt and looks only at operating assets and liabilities.