What is Working Capital? Formula and Practical Significance

Working capital shows the difference between current assets and current liabilities. It indicates how much short-term financing a business has available for its daily operations.

Working Capital = Current Assets − Current Liabilities

With 3 million Norwegian Kroner (NOK) in current assets and 2.2 million NOK in current liabilities, the working capital is 800,000 NOK.

What is Included?

Current assets can include bank deposits, accounts receivable, and inventory. Current liabilities can include accounts payable, accrued taxes/fees, and loans that mature in the short term.

Positive working capital means that current assets exceed current liabilities. This typically provides a buffer, but the quality of the assets is crucial. Old accounts receivable or obsolete goods may have low liquidity.

Can Negative Working Capital Be Normal?

Yes, in some business models. Retail stores may receive payment from customers before supplier invoices (accounts payable) are due. Subscription companies may receive advance payments. For other companies, negative working capital can be a sign of financial pressure.

Cash Conversion Cycle

Working capital is tied up when goods are purchased and invoices are awaiting payment. It is released when the customer pays. A business can improve its situation by reducing inventory days, invoicing quickly, and following up on overdue claims, without damaging customer or supplier relationships.

Working Capital and Growth

Growth often requires more inventory and larger accounts receivable before cash is received. A profitable business can therefore experience liquidity problems if growth is not adequately financed.

How Proffi Should Present Working Capital

Show the amount along with current assets, current liabilities, liquidity ratios, and development over time. Compare it with the company's size and industry, not just an absolute monetary amount.