Working Capital: What It Is, How to Calculate It, and Why It’s Your Financial Heartbeat
In business, few metrics reveal as much about real financial health as working capital. It’s the financial pulse of your company—the indicator that tells you whether daily operations can keep running without suffocating. And yet, it’s still one of the most ignored—or worse, misunderstood—concepts among founders and executives.
Managing working capital well is the difference between a company that grows with balance and one that “dies from success,” trapped between invoices to collect and bills that must be paid today.
What is working capital?
Working capital (WC) is the difference between current assets and current liabilities.
Working Capital = Current Assets – Current Liabilities
- Current assets: cash, accounts receivable, inventory, and other liquid resources expected to turn into cash within a year.
- Current liabilities: payables, short-term taxes, payroll due, and other obligations due within the same period.
Positive working capital usually means you can meet short-term obligations without stress. Negative working capital signals liquidity risk, although it doesn’t always mean failure (for example, some models collect cash very fast).
The formula is simple, the meaning isn’t
A common mistake is thinking that “positive” automatically means “healthy.” In finance, context gives meaning to the number.
- Too high can mean cash is trapped in receivables or inventory, hurting profitability.
- Too low or negative may mean you rely on external financing or trade credit to operate.
The goal isn’t to hoard cash. It’s to keep a dynamic balance between efficiency and safety.
Practical example
Imagine your company has:
- Current assets: €250,000
- Current liabilities: €200,000
Then:
Working Capital = 250,000 – 200,000 = €50,000
That means you have €50,000 to fund operations after covering short-term obligations.
Looking at two consecutive years:
| Year | Current Assets | Current Liabilities | Working Capital |
|---|---|---|---|
| 2024 | €250,000 | €200,000 | €50,000 |
| 2025 | €310,000 | €290,000 | €20,000 |
Working capital has decreased. That can be an early warning: the company is growing, but its buffer is shrinking.
Why working capital is the financial heart of your business
- It fuels daily operations. Without working capital, you can’t pay salaries, materials, or suppliers. You can have great margins on paper, but without liquidity, you collapse before the next invoice is collected.
- It measures operational efficiency. Balanced working capital usually reflects a healthy operating cycle. Excess inventory or slow collections are inefficiencies working capital makes visible.
- It reveals growth capacity. Fast growth requires financing: more stock, more customer credit, more costs before revenue. If working capital doesn’t keep up, growth becomes a liquidity trap.
- It impacts valuation and solvency. Analysts and investors review working capital to assess stability. Healthy working capital builds confidence; stressed working capital raises doubts.
Cash Conversion Cycle: the key complement
Working capital becomes clearer when paired with the Cash Conversion Cycle (CCC), which measures how long it takes to turn inventory investment into cash, considering:
- Days Inventory Outstanding (DIO): average time inventory stays in storage.
- Days Sales Outstanding (DSO): average time to collect receivables.
- Days Payables Outstanding (DPO): average time to pay suppliers.
CCC = DIO + DSO – DPO
The lower the CCC, the better: you get cash back faster and rely less on external financing.
CCC example
Suppose a company:
- Holds inventory for 30 days
- Collects from customers in 45 days
- Pays suppliers in 60 days
CCC = 30 + 45 – 60 = 15 days
It only needs to finance 15 days of operations with its own resources—excellent management.
But if the company reduces DPO to 30 days, the CCC increases to 45 days, doubling the need for working capital. Profitability hasn’t changed, but liquidity has deteriorated.
How to optimize working capital
Working capital management is not about cutting costs. It’s about accelerating the money cycle.
Improve customer collections
- Automate invoicing and reminders.
- Offer early-payment discounts.
- Review credit terms: loyal customers aren’t always profitable if they pay late.
Negotiate better supplier terms
- Extend payment terms when possible without damaging relationships.
- Explore consignment or deferred-payment agreements.
- Centralize purchasing to increase bargaining power.
Reduce inventory without hurting service
- Use Just-in-Time approaches or demand forecasting models.
- Identify slow-moving items and clear them.
- Maintain continuous inventory and turnover control.
Automate and centralize financial management
BI tools and low-code automation (for example, n8n or Power Automate) let you monitor cash flows in real time, detect deviations, and act before they become crises.
Working capital as a strategic indicator
Beyond accounting, working capital is a strategic compass. When analyzed together with ratios like the current ratio, quick ratio, or debt-to-equity, it shows the true sustainability of the business.
| Metric | Formula | What it measures |
|---|---|---|
| Current Ratio | Current Assets / Current Liabilities | General ability to cover short-term debt |
| Quick Ratio | (Current Assets – Inventory) / Current Liabilities | Immediate liquidity without relying on inventory |
| Working Capital | Current Assets – Current Liabilities | Financial buffer / room to operate |
A low quick ratio plus tight working capital can be an early warning: if sales drop or a major customer delays payment, operations can run out of liquidity.
Common working capital mistakes
- Confusing profit with liquidity: a profitable company can fail if it doesn’t collect on time.
- Not forecasting cash flow: reactive firefighting destroys buffer.
- Funding short-term needs with long-term debt without a clear plan: it distorts indicators and creates false stability.
- Not measuring the full operating cycle: if you don’t know how many days cash takes to return, you’re guessing.
How to analyze your working capital
A good starting point is a quarterly check with three questions:
- Is working capital increasing or decreasing versus the previous period?
- What is my CCC and how has it changed?
- Where is cash trapped: inventory, receivables, or payables?
In consulting, working capital is often analyzed together with operating cash flows and revenue projections to detect whether growth is sustainable—or turning into imbalanced growth.
A real example: growing without liquidity
A distribution company increased revenue by 40% in one year. On paper, a success. But working capital collapsed: collections went from 30 to 60 days, inventory grew, and payments stayed immediate.
Result: the business relied on credit lines every month, paying rising interest. The issue wasn’t profitability—it was the operating cycle.
After redesigning collections and adjusting payment terms, working capital recovered within six months and the company could finance growth internally.
Summary
Working capital is far more than an accounting figure: it’s the financial heart that keeps operations alive.
- If it beats “too fast” (too much inventory or slow collections), it drains resources.
- If it beats “too slow” (too little liquidity), it risks survival.
The art is maintaining a healthy rhythm aligned with your strategy.
What next?
If you’re not sure whether your company is managing working capital well, it’s time to review your financial and operational processes.
At Ayram.es, I help executives evaluate, optimize, and automate liquidity management—so every euro works efficiently inside the organization.