Definition

Working Capital

The money tied up in running the business day to day, and what it says about how the business is run.

Brian Feroldi

By Brian Feroldi, co-founder of Long Term Mindset

Investing since 2004. 3,000+ articles for the Motley Fool. Author of Why Does The Stock Market Go Up?

Last updated

Working capital is the difference between a company's current assets and its current liabilities: what it owns that will convert to cash within a year, minus what it owes within a year. It measures short-term liquidity, and its direction over time says as much about the business as its level.

FormulaCurrent Assets − Current Liabilities

Three ways to calculate it

The simple version subtracts all current liabilities from all current assets. It is the standard definition and it mixes two different things: how the business operates, and how it is financed.

The narrow version strips out cash on the asset side and short-term debt on the liability side, which isolates the operating position from financing decisions. The specific version goes further still, keeping only the three lines that actually move with trading: accounts receivable plus inventory, minus accounts payable. That last one is what most analysts mean when they talk about working capital changing.

Worked example

A company holds $400M of cash, $300M of receivables and $250M of inventory, against $180M of payables, $120M of short-term debt and $100M of other current liabilities.

Simple: $950M − $400M = $550M
Narrow: $550M − $280M = $270M
Specific: ($300M + $250M) − $180M = $370M

Three defensible numbers for the same balance sheet. Pick one and use it consistently, because the comparison across years is where the information lives.

Why the direction matters more than the level

Working capital that grows faster than revenue is one of the quieter warning signs in financial analysis. It usually means receivables are ageing, because customers are paying more slowly or the company is selling to weaker ones, or inventory is building, because the product is moving less easily than forecast.

Both consume cash without appearing on the income statement. This is exactly how a company reports rising profits while its bank balance falls, and it is why the cash flow statement catches deterioration that the income statement hides.

Negative working capital is often excellent

The textbook reading is that negative working capital signals distress. For a large group of businesses it signals the opposite: enormous negotiating power.

A supermarket sells stock for cash in days and pays suppliers in weeks. A subscription business collects a year upfront and delivers monthly. In both cases the customer and the supplier are funding the operation, which means growth generates cash instead of consuming it. Negative working capital from that source is one of the strongest structural advantages a company can have.

The distinction is where the negative number comes from. Deferred revenue and stretched payables backed by real leverage are a strength. Payables stretched because the company cannot pay are a symptom.

What to actually check

Where working capital sits on the balance sheet

Which lines count as current, which do not, and the three calculations laid out side by side so the difference between them is visible.

Working Capital infographic by Brian Feroldi. Defines working capital as the difference between a company's current assets and current liabilities, illustrated on a balance sheet diagram that separates current assets, cash and equivalents, marketable securities, accounts receivable, inventory and other current assets, from current liabilities, payables and accrued expenses, short-term debt and other current liabilities, with long-term assets, long-term liabilities and shareholder equity shown below. Notes that working capital, also called net working capital, measures liquidity and short-term financial health. Gives three ways to calculate it: simple, current assets minus current liabilities; narrow, current assets excluding cash minus current liabilities excluding debt; and specific, accounts receivable plus inventory minus accounts payable.
Working Capital. Original graphic by Brian Feroldi.
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See the balance sheet in the context of the phase

Working capital building during hyper growth usually means the company is stocking up for demand. The same build during decline usually means the demand did not arrive. Phase Check places any US-listed company on the lifecycle so you know which reading applies.

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Frequently asked questions

A current ratio between 1.5 and 2.0 is the textbook comfort zone, but it varies enormously by industry. Supermarkets and subscription businesses routinely operate below 1.0 and are perfectly healthy, because their customers pay before their suppliers do.
Not necessarily, and often the reverse. When it comes from collecting cash from customers before paying suppliers, as supermarkets and subscription businesses do, it means growth funds itself. It is only a warning when payables are stretched because the company cannot afford to pay them.
Directly. An increase consumes cash, because money is tied up in receivables or inventory. A decrease releases it. The change appears as a line in the operating section of the cash flow statement, and it is frequently the reason profit and cash flow diverge in a given year.
They are usually used interchangeably for current assets minus current liabilities. Some analysts reserve net working capital for the narrower version that excludes cash and short-term debt, in order to isolate the operating position from financing choices. Check which definition a source is using.
Because it consumes cash without touching the income statement. Working capital growing faster than revenue usually means receivables are ageing or inventory is building, both of which suggest the product is moving less easily than the reported profit implies.

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