How to Calculate Working Capital for Your Business
Buying your Christmas stock months early makes sense… right up until you're standing in a storage unit full of boxes with the unit’s rent due next week.
Working capital tells you whether your cash, plus what you can turn into cash over the next year, will cover the bills due in that time.
Search for the working capital meaning and you'll find lots of versions packed with accounting jargon. The simple working capital definition is what your company owns that will turn into cash within the next 12 months, minus what it has to pay within those same 12 months.
When the result is positive, your short-term money covers your short-term bills with something left over.
If it drops below zero, paying everything due this year would mean finding cash from somewhere else, like future sales or a loan.
Learning how to calculate working capital only takes a couple of minutes.
Current assets are anything your company owns that should become cash within a year.
For most small companies, that means the money in your business account, invoices customers haven't paid yet, stock you plan to sell, and bills you've paid in advance, like a year of insurance, which is cash you won't need to find later.
Current liabilities are everything you owe that's due within a year.
Supplier invoices go here, along with VAT you've charged and need to pass on to HMRC, PAYE for your team, Corporation Tax, and any loan repayments or credit card balances due in the next 12 months.
Once you've got both groups, it's four steps:
- Add up your current assets.
- Add up your current liabilities.
- Subtract your current liabilities from your current assets. The result is your working capital.
- Divide your current assets by your current liabilities if you want the working capital ratio as well.
If your company has £18,000 in account and £12,000 in unpaid client invoices, your current assets come to £30,000. Add £9,000 owed to suppliers and HMRC and £6,000 of loan repayments due this year, and your current liabilities are £15,000.
Take one from the other and you're left with £15,000 of working capital. Divide £30,000 by £15,000 and you get a ratio of 2, so every pound you owe is covered twice.
Your annual accounts have already done the sum for you. The balance sheet usually has a line called "net current assets (liabilities)", and that figure is your working capital on the last day of your financial year.
Anything above 1 means you can cover this year's bills, as long as the stock sells and the invoices get paid. Below 1, you're relying on money that hasn't come in yet.
Tracking the ratio month to month shows whether your position is getting stronger or weaker.
If your number comes out low or negative, look at how your business gets paid before you start worrying, though.
Your number can sit below zero for years without trouble if cash comes in faster than the bills go out. A café takes payment at the till and pays its coffee supplier at the end of the month, so it always holds a few weeks of its suppliers' money.
As long as customers keep coming through the door, the bills get paid on time.
It's a different story if you pay your costs upfront and then wait to be paid, like an agency on 60-day client terms or an online shop buying stock months before the busy season.
In that case, a falling number is an early signal to act.
Fast growth can leave a profitable company short of cash.
Every new order costs money before it brings any in. You buy the materials, pay your team to do the work and send the invoice, then wait 30 or 60 days for the money. Double your orders and you double the cash going out before any of it comes back.
So a record quarter can leave your account lower than a quiet one. Running out of cash while sales are climbing is overtrading, and it can happen right in your busiest month.
Checking working capital before you take on a big new contract tells you how much of the upfront cost you can carry yourself, and how much you'll need to cover another way.
If your number is lower than you'd like, most fixes are getting money in sooner or paying it out later, while keeping your clients and suppliers happy.
Start with invoicing. Send invoices the day the work is finished, and look at your payment terms. Moving new clients from 30-day terms to 14 frees up cash fast. Taking card payments online helps too, because the customer pays when they buy.
Once your suppliers know you always pay on time, ask about longer terms. Most will at least hear you out.
Then check your stock. Boxes on a shelf count as a current asset, but you can't pay HMRC with them, so buying in smaller batches closer to your busy season keeps more cash in your account.
Tax bills are the easiest costs to see coming.
VAT and Corporation Tax sit in your current liabilities from the moment they're owed, so moving a share of each customer payment into a separate pot as it arrives keeps your tax deadlines from turning into a scramble.
Sometimes the gap is temporary and you can already see the cash on its way, like a large order you need to buy materials for before the customer pays.
A short-term loan can cover that window. If you have an Ampere business account, you can apply for a business loan through our lending partners, with terms built around your cash flow and funds in your account within two days of approval.
Checking working capital once a year gives you a number that's already months out of date. A quick monthly check keeps it current, and all it takes is two totals and one subtraction.
