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Working capital is the difference between a company's current assets and its current liabilities. It measures whether a business has enough short-term resources to cover its short-term obligations. A positive working capital figure means the company can pay its bills today. A negative figure means it cannot, at least not without additional financing or asset sales.
Think of working capital like your personal checking account balance versus your monthly bills: if the balance exceeds what you owe, you are solvent in the short term.
Working Capital = Current Assets - Current Liabilities
Current assets include cash, accounts receivable, inventory, and prepaid expenses, anything convertible to cash within one year. Current liabilities include accounts payable, accrued expenses, short-term debt, and any portion of long-term debt due within the next 12 months. The resulting number tells you the cushion, or shortfall, between the two.
The raw dollar amount of working capital is useful but incomplete. A company with $1 million in working capital might look healthy until you realize it has $50 million in current liabilities. Two ratios provide more useful context.
The current ratio divides current assets by current liabilities. A ratio above 1.0 means current assets exceed current liabilities. Most analysts look for a current ratio between 1.5 and 2.0 for industrial companies as a sign of comfortable liquidity. The quick ratio excludes inventory from current assets before dividing, giving you a more conservative liquidity estimate useful for businesses where inventory cannot be quickly converted to cash.
Businesses that collect cash before delivering their product or service can operate comfortably with negative working capital. Amazon collects customer payments immediately but pays its suppliers on 30- to 60-day terms. That structure creates a natural float of cash that funds operations even when current liabilities exceed current assets. Supermarkets and subscription-based businesses often show the same pattern.
For capital-intensive manufacturers or professional services firms that invoice after work is complete, negative working capital is a serious red flag signaling a potential cash crisis.
Working capital changes every time one of its components moves. Collecting receivables faster reduces accounts receivable and adds cash, improving working capital. Buying more inventory increases the asset side but reduces cash, leaving working capital unchanged. Taking on more accounts payable reduces working capital if the liability grows faster than assets do.
Analysts track changes in working capital on the cash flow statement under operating activities. Rising working capital that is not matched by earnings growth often signals that the business is stretching to fund growth, which can be fine temporarily but dangerous if the trend continues.
Sources:
https://www.fasb.org/
https://www.sec.gov/cgi-bin/browse-edgar
https://www.aicpa.org/
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