Working Capital

What is Working Capital?

Working capital is the difference between current assets (cash, receivables, inventory) and current liabilities (payables, short-term debt). It measures your ability to cover short-term obligations and fund daily operations.

Positive working capital means you have enough liquid assets to pay near-term bills. Negative working capital means you might struggle to meet obligations without additional financing.

Why Working Capital Matters

Working capital is the fuel for daily operations. You need it to pay suppliers, cover payroll, and maintain inventory while waiting for customer payments. Insufficient working capital causes cash crunches even in profitable businesses.

Managing working capital efficiently improves cash flow. Collect receivables faster, negotiate longer payment terms with suppliers, and optimize inventory levels.

How to Calculate Working Capital Step by Step

Step 1: List your current assets. These are assets you can convert to cash within 12 months:

• Cash and equivalents: $320,000
• Accounts receivable: $85,000
• Prepaid expenses: $12,000
• Short-term investments: $50,000
• Total Current Assets: $467,000

Step 2: List your current liabilities. These are obligations due within 12 months:

• Accounts payable: $45,000
• Accrued salaries: $60,000
• Deferred revenue (unearned): $95,000
• Short-term debt: $30,000
• Credit card balances: $8,000
• Total Current Liabilities: $238,000

Step 3: Subtract.

• Working Capital = $467,000 - $238,000 = $229,000
• Working Capital Ratio = $467K ÷ $238K = 1.96

Healthy. You have nearly $2 in current assets for every $1 in current liabilities.

Step 4: Note the SaaS-specific nuance with deferred revenue. The $95K in deferred revenue is a liability because you've been paid but haven't delivered the service yet. However, it's unlikely you'll need to return that cash. You'll earn it by delivering the service. Some founders calculate an "adjusted" working capital excluding deferred revenue for a more realistic picture.

Step 5: Track changes month-over-month. Declining working capital is an early warning sign. If you see working capital dropping while revenue grows, your cash conversion cycle may be lengthening. You're growing but cash isn't keeping up.

Common mistakes founders make:

• Ignoring deferred revenue's impact (it inflates liabilities for SaaS companies)
• Including long-term assets or liabilities in the calculation
• Not separating operational working capital from total working capital
• Assuming positive working capital means you're safe (the composition matters: $300K in receivables and $10K in cash is very different from $300K in cash)

Working Capital Ratio

The ratio of current assets to current liabilities should be 1.5-2.0 for most businesses. Below 1.0 is dangerous. Above 2.0 might mean you're not deploying capital efficiently.