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What is working capital?
Working capital is the difference between a business's current assets and liabilities. Assets can include cash, accounts receivable or other items that will become cash within the next 12 months, while liabilities include expenses like payroll, accounts payable and debt payments due in the next 12 months.
If you're facing a temporary shortfall, getting a working capital loan is one way to give your business a quick infusion of cash. But this type of financing doesn't make sense if you need to finance a long-term investment, like an expansion. Consider other small-business loans for that type of capital.
Why working capital is important
Working capital is an important indicator of a business’s financial health because it measures what small businesses have on hand to cover day-to-day expenses. Working capital acts as a cushion and offers opportunities for growth.
Working capital has two other important characteristics:
It gives businesses borrowing power. Lenders and other creditors look at working capital as a measure of a company’s overall health and a business’s ability to take on new debt.
It can fluctuate. Even successful businesses struggle with maintaining enough working capital, especially seasonal businesses and companies with large volumes of accounts receivable. Analyzing your business’s financials regularly, including the balance sheet and profit and loss statement, can help you plan to meet potential shortfalls.
How do you calculate working capital?
The working capital formula is:
Current assets – current liabilities = working capital
You can find accounting software that automatically tracks working capital for you.