Working capital is critical to the success of a business. It pays all the day-to-day expenditures including payroll, supplies, inventory, maintenance, rent, and anything else that can be included as overhead. Without working capital, a business would have to shut its doors almost immediately. Because these funds are so important, it’s also important to know how to calculate them. 

Calculating Working Capital

Knowing how much working capital your business has can show you how far into the future your business can operate on current funds. The further into the future your balance stays on the positive side the longer you can operate without further income. The sooner your balance falls into the negative, the sooner you’ll need to do something to get profits back up. 

So, how do you calculate your working capital? It’s actually a simple equation. You take your liabilities, which is everything you have to pay out of the business and subtract them from your assets, which is everything that has come into the business, which would be your recent sales and any funds your business has in the bank. 

The Ration Formula

There are also times, such as when applying for a loan, you may need to know your ratio of assets to liabilities. Knowing your ratio can show you how far into the future your business could last without bringing in more income or more liability, or, how many times you can make your existing liability payments with your existing income. 

The ration formula takes your current assets and divides them by your current liabilities. For example, if your current assets are $800, but your current monthly liabilities are $200, then you would divide $800 by $200. Of course, the answer is 4, which is your working capital ratio. 

The Right Numbers

Ideally, your business should have a ratio between 1 and 2. Anything less could be telling of problems to come, while anything over signals you’re holding onto cash that could be doing bigger things for your business, such as investing in new equipment or another business venture. 

You should calculate your working capital and your ratio on a regular basis to understand the health of your business. Knowing these numbers equips you to make better business decisions. Calculating your working capital and its ratio is simple enough that any business owner can do it for themselves, but if you ever question your numbers, always talk to your accountant to make sure you’re not missing anything.