Working capital represents a company’s ability to pay its current liabilities with its current assets.
The figure for working capital gives investors an indication of the company’s short-term financial health, its capacity to clear its debts within a year, and its operational efficiency.
To calculate working capital, subtract a company’s current liabilities from its current assets.
Key Takeaways
- Working capital is the amount of capital that a company can readily use for day-to-day operations.
- It represents a company’s liquidity, operational efficiency, and short-term financial health.
- Subtract a company’s current liabilities from its current assets to calculate working capital.
- A positive amount of working capital means that a company can meet its short-term liabilities and continue its day-to-day operations.
- Current assets divided by current liabilities, called the current ratio, is a liquidity ratio often used to gauge short-term financial well-being. It’s also known as the working capital ratio.
Components of Working Capital
Current Assets
Current assets are assets that a company expects to use or sell within one year or one business cycle, whichever is less.
Importantly, they are easily converted to cash. They don’t include long-term or illiquid investments such as certain hedge funds, real estate, or collectibles.
Examples of current assets include:
- Checking and savings accounts
- Highly liquid marketable securities such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs)
- Money market accounts
- Cash and cash equivalents
- Accounts receivable
- Inventory and other shorter-term prepaid expenses
- Current assets of discontinued operations and interest payable
Current Liabilities
Current liabilities are all the debts and expenses that the company expects to pay within a year or one business cycle, whichever is less. They typically include:
How to Calculate Working Capital
To calculate working capital, subtract current liabilities from current assets.
The metric known as the current ratio can be useful as well when assessing working capital. Also known as the working capital ratio, it provides a quick view of a company’s financial health.
You can calculate the current ratio by taking current assets and dividing that figure by current liabilities.
A resulting ratio of more than one means that current assets exceed liabilities. They can cover the bills with some cash left over.
Generally, the higher the ratio, the better a company’s ability to pay short-term liabilities.
But a very high current ratio means there is a large amount of available current assets. That can indicate that a company isn’t utilizing its excess cash as effectively as it should to generate growth.
Working Capital Example: Coca-Cola
The Coca-Cola Co. (KO) had current assets valued at $25.99 billion as of Dec. 31, 2024. They included cash and cash equivalents, short-term investments, marketable securities, accounts receivable, inventories, and prepaid expenses.
Coca-Cola also registered current liabilities of $25.25 billion for that fiscal year. The company’s current liabilities consisted of accounts payable, accrued expenses, loans and notes payable, current maturities of long-term debt, and accrued income taxes.
Its working capital was $740 million:
$25.99 billion – $25.25 billion = $740 million
Furthermore, Coca-Cola’s current ratio was 1.03:
$25.99 billion ÷ $25.25 billion = 1.03
Does Working Capital Change?
Working capital amounts can change over time as a company’s current liabilities and current assets change. For example:
Long-Term Assets and Debt Can Become Current
The exact working capital figure can change every day depending on the nature of a company’s debt.
What was once a long-term liability, such as a 10-year loan, becomes a current liability in the ninth year, when the repayment deadline is less than a year away.
What was once a long-term asset, such as real estate or equipment, can suddenly become a current asset when a buyer is lined up.
Current Assets Can Be Written Off
Working capital can’t be depreciated as a current asset the way long-term, fixed assets are. Some working capital related to inventory can lose value or even be written off, but that isn’t recorded as depreciation.
Fast Fact
Working capital can only be expensed immediately as one-time costs to match the revenue they help generate in the period.
Assets Can Be Devalued
Working capital can’t lose its value to depreciation over time, but it may be devalued when some assets have to be marked to market.
This can happen when an asset’s price is below its original cost and other assets aren’t salvageable. Two common examples of this are inventory and accounts receivable.
Inventory
Inventory obsolescence can be a real issue in operations. The market for the inventory has priced it lower than the inventory’s initial purchase value as recorded in a company’s books.
A company marks the inventory down to reflect current market conditions and uses the lower of cost or market method, resulting in a loss of value in working capital.
Accounts Receivable
Some accounts receivable may become uncollectible at some point and have to be totally written off, representing another loss of value in working capital.
It may take longer-term funds or assets to replenish the current asset shortfall because such losses in current assets reduce working capital below its desired level. This is a costly way to finance additional working capital.
Unearned revenue from payments received before the product is provided will also reduce working capital. This revenue is considered a liability until the products are shipped to the client.
Important
Working capital should be assessed periodically to ensure that no devaluation occurs and that there’s enough left to fund continuous operations.
More About the Current Ratio
A healthy business has working capital and thus, the ability to pay its short-term bills. As mentioned above, a current ratio of more than one indicates that a company has enough current assets to cover bills that are coming due within a year.
The higher the ratio, the greater a company’s short-term liquidity and its ability to pay its short-term liabilities and debt commitments.
It also means that the company can continue to fund its day-to-day operations. The more working capital a company has, the less likely it is to take on debt to fund the growth of its business.
A company with a current ratio of less than one, known as negative working capital, is considered risky by investors and creditors because it demonstrates that the company might not be able to cover its debts if needed.
We can see in the chart below that Coca-Cola’s working capital, as defined by the current ratio, increased over the years. This indicates improving short-term financial health.
Special Considerations
A more stringent liquidity ratio is the quick ratio. This measures the proportion of short-term liquidity compared to current liabilities.
The difference between this and the current ratio is in the assets, which include only cash, marketable securities, and receivables. The quick ratio excludes inventory because it can be more difficult to turn into cash rapidly.
What Is Working Capital?
Working capital is the amount of money that a company can quickly access to pay bills due within a year and to use for its day-to-day operations. It can represent the short-term financial health of a company.
How Does a Company Calculate Working Capital?
The formula is current assets minus current liabilities. The result is the amount of working capital that the company has at that time. Working capital amounts can change.
What Does Working Capital Indicate?
Working capital can be a barometer for a company’s short-term liquidity and financial well-being. A positive amount of working capital indicates good short-term health. A negative amount indicates that a company may face liquidity challenges and may have to incur debt to pay its bills.
The Bottom Line
Working capital is the difference between a company’s current assets and current liabilities.
A challenge in assessing working capital is in properly categorizing the vast array of assets and liabilities on a corporate balance sheet.
The better the categorizing, the more reliable the ability of a company to meet its short-term financial commitments and the view of its overall health.
