Your Quick Guide To Working Capital Ratio

Most businesses go bankrupt not because they’re not making profits but because they run dry of cash. Hence, meeting their current payment obligations becomes challenging. However, an organization can run out of cash due to increasing capital requirements for new investments as they expand. 

Working capital ratio(NWC) is a fundamental financial ratio that provides invaluable information about a business’s short-term financial health and operation efficiency. By definition, it’s the sum of an entity’s current assets (cash, inventories and receivables) and the current liabilities (mortgage, bank loans and short-term debts). 

This quick guide focuses on how to calculate the working capital ratio to determine a company’s liquidity. It will further provide the clearest definition and practical meaning retrieval for business. 

1. Understanding Working Capital Ratio 

A business can determine its growth by gauging its financial ability to pay for liabilities as they occur. Otherwise, focusing on profit alone doesn’t necessarily mean a healthy balance sheet. You need to manage your working capital, as it impacts your business’s success.  

The working capital ratio or current ratio is a measure of how the company manages its short-term cash flow needs based on its current fund accessibility and short-term financial obligations. It is calculated by dividing the sum of current assets by current liabilities. 

The formula is as follows: 

Working Capital=Current Assets/Current Liabilities 

Current assets cover invoices for bills up to their due dates and goods inventory in stores with a one-year expectation of liquidation. As compared, short-term unpaid accounts, immediate expenses, and short-term debt obligations that are supposed to be cleared within a year are categorized into the current liabilities category. 

The working capital ratio is one of the main tools that allows business analysts to understand a company’s operation and financial stability. It is commonly used as a key indicator to gauge the business’s well-being.