Working Capital
GeneralNet Working Capital
The difference between a company's current assets (cash, receivables, inventory) and current liabilities (payables, short-term debt). Positive working capital means the business can meet short-term obligations; negative indicates potential liquidity stress.
Definition
Working capital is the difference between a company's current assets and current liabilities — the capital available to fund day-to-day business operations.
Working Capital = Current Assets − Current Liabilities
Where:
- Current Assets = Cash, bank balances, accounts receivable (debtors), inventory, prepaid expenses (due within 12 months)
- Current Liabilities = Accounts payable (creditors), short-term debt, accrued expenses (due within 12 months)
Positive working capital means the business can fund its short-term obligations from its liquid assets. Negative working capital can indicate distress — or, for businesses with strong supplier credit and fast cash collection, a sign of business quality.
Working capital management is a core function of corporate finance, balancing the trade-off between liquidity (holding more current assets) and profitability (deploying assets efficiently).
Formula
Working Capital = Current Assets − Current Liabilities
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = (Current Assets − Inventory) / Current Liabilities (more conservative)
Working Capital as % of Revenue = Working Capital / Annual Revenue × 100
Cash Conversion Cycle = DIO + DSO − DPO
(DIO = Days Inventory Outstanding, DSO = Days Sales Outstanding, DPO = Days Payable Outstanding)
Worked Example
Anisha runs a textile manufacturing business.
| Current Assets | Current Liabilities | ||
|---|---|---|---|
| Cash | ₹5L | Creditors (suppliers) | ₹12L |
| Receivables | ₹20L | Short-term bank loan | ₹8L |
| Inventory | ₹18L | Accrued expenses | ₹3L |
| Total | ₹43L | Total | ₹23L |
Working Capital = ₹43L − ₹23L = ₹20 lakh
Current Ratio = ₹43L / ₹23L = 1.87 (healthy)
Cash Conversion Cycle: Inventory is held 45 days → customers pay in 60 days → she pays suppliers in 30 days. CCC = 45 + 60 − 30 = 75 days — capital is tied up for 75 days on average.
Reducing the CCC to 50 days would release approximately ₹7 lakh in cash (from faster collections or extended supplier payment terms).
Key Things to Know
- Working capital vs free cash flow: An increase in working capital is a cash outflow in the free cash flow calculation. High-growth businesses often consume significant cash in working capital even while reporting accounting profits. This is why "profit" and "cash flow" can differ significantly during growth phases.
- Seasonal working capital: Many businesses have highly seasonal working capital needs — a garment manufacturer peaks in inventory before Diwali, a resort peaks in receivables in winter. Banks offer working capital credit facilities calibrated to these cycles, typically as overdraft or cash credit facilities.
- Working capital in SME lending: For MSME businesses in India, working capital loans are the most common form of bank credit. Banks assess the working capital cycle, debtor quality, and inventory levels before sanctioning. The working capital limit is typically based on 25% of projected annual turnover (a common bank heuristic).
- EBITDA vs cash flow gap: A business with high EBITDA but poor working capital management may be cash-poor. High debtor days (slow collection from customers) can trap cash in receivables even as profitability is strong. Comparing EBITDA to operating cash flow reveals how well a business converts profits to actual cash.
- Negative working capital as moat: Amazon's negative working capital model — selling products before paying suppliers — is a structural competitive advantage. In India, large retailers like D-Mart operate similarly: low inventory days, minimal credit sales, strong supplier payment terms. This creates a self-funding growth model that doesn't require external working capital financing.