Working Capital: Definition, Calculation and Optimisation for Businesses

Working capital is a key metric for assessing short-term financial stability. It describes the difference between current assets and current liabilities.

To run a company successfully, working capital should be effectively dealt with. We will explain how to calculate and assess working capital, how to improve it and which tools can help you.

Many finance teams still work with fragmented Excel files and manual reports affecting transparency and the timeliness of working capital calculations. We show you how to calculate key figures quickly and accurately in real time.

What is Working Capital? Definition Simply Explained

Working capital is the difference between current assets and current liabilities. It shows how much short-term capital a company has left after deducting short-term payments. The calculated figure is important for assessing a company’s liquidity. The calculation is as follows:

Working Capital = Current Assets – Current Liabilities

Current Assets: Which Items Are Included?

Current assets include all assets that are short term. These include liquid funds such as bank balances, inventories and trade receivables. They can be used, sold or converted into cash at short notice.

Current Liabilities: What Is Deducted?

Current liabilities include all obligations that are due within one year. These include trade payables and short-term loans. Tax liabilities from VAT, trade tax or corporate income tax are also part of current liabilities.

Important: For finance and treasury teams, it is not only the amount of liabilities that matters. The due date of individual payments is also decisive. Due dates influence short-term liquidity and cash flow.

Working Capital Formula and Calculation

The following formula is used to calculate working capital:

Working Capital = Current Assets – Current Liabilities

Working capital can be determined step by step:

• Step 1: Determine current assets from the balance sheet

• Step 2: Determine current liabilities

• Step 3: Deduct liabilities from current assets

• Step 4: Interpret the result

It is important to note that this formula is based on balance sheet values. The result is a snapshot. This is not enough for sound decisions on important financial matters. Finance teams need up-to-date cash positions, payment flows and liquidity forecasts. Together, working capital and cash forecasting enable forward-looking financial management.

Working Capital Example Calculation

Position	Amount
Inventories	600.000 €
Trade Recievables	900.000 €
Liquid funds	300.000 €
Total Current assets	1.800.000 €
Current Liabilities	1.100.000 €
Working Capital	700.000 €

Based on this balance sheet, we can calculate working capital:

• Step 1: Determine current assets from the balance sheet

  -> €600,000 inventories + €900,000 trade receivables + €300,000 liquid funds = €1,800,000

  
  

• Step 2: Determine current liabilities

  -> Current liabilities = €1,100,000

  
  

• Step 3: Deduct liabilities from current assets

  -> €1,800,000 - €1,100,000 = €700,000 working capital

  
  

• Step 4: Interpret the result

  The company has positive working capital of €700,000. This means that short-term assets exceed short-term liabilities. In principle, this is a positive signal for liquidity and financial stability.

The result does not mean that €700,000 is automatically available as cash immediately. The capital may be tied up in inventories and receivables. For treasury teams, the link to liquidity planning is therefore decisive.

Are Liquid Funds Included in Working Capital?

The working capital definition can vary from company to company. There are two forms:

• Net Working Capital: In the broad definition, liquid funds count as current assets. They are therefore included in the working capital calculation.

  
  

• Operating Working Capital: Liquid funds are deliberately excluded. This places a stronger focus on the other components of current assets.

Key figure	Components
Net Working Capital	Current assets including liquid funds – current liabilities
Operating Working Capital	Inventories + trade receivables – trade payables

Positive and Negative Working Capital: Which Is Better?

Whether positive, negative or high working capital is desirable cannot be determined in general terms. The assessment depends on the industry, business model, seasonality and payment terms. In principle, however, the following guidelines apply:

Situation	Meaning	Recommended action
Positive Working Capital	Current assets exceed current liabilities. The company generally has sufficient liquidity to finance ongoing business.	Monitor regularly and check whether capital is being used efficiently.
Negative Working Capital	Current liabilities are higher than current assets. This may indicate liquidity risks, but it does not necessarily have to be a problem.	Monitor cash flows, due dates and liquidity forecasts closely.
Very High Working Capital	May indicate high inventories, long payment terms or slow receipt of receivables. More capital is often tied up than necessary.	Analyse capital tied up and check optimisation potential in inventories and receivables.

Net Working Capital: Difference and Practical Meaning

Net working capital (NWC) is often used as a synonym for working capital. In practice, however, a distinction is made between net working capital and operating working capital. Both figures describe the difference between short-term assets and short-term liabilities. However, they place different emphasis. That is why liquid funds are often excluded from operating working capital.

In practice: Two companies can report the same net working capital. However, their operating working capital can vary significantly. This may be because one company has longer payment terms for invoices, for example. For this reason, there is no ideal value for net working capital. CFOs must assess the figure in context.

Interpreting the Working Capital Ratio Correctly

The working capital ratio can be calculated as follows:

Working Capital Ratio = Current Assets ÷ Current Liabilities

It shows the relationship between current assets and current liabilities. The value can be interpreted as follows:

• >1: Current assets exceed current liabilities

• = 1: Current assets and current liabilities are balanced

• < 1: Current liabilities are higher than current assets

How High Should the Working Capital Ratio Be?

A high working capital ratio is not automatically better. Very high values can indicate high inventories or slow receipt of receivables. This can tie up unnecessary capital. The figure should therefore always be viewed in context.

As a rough guide, a working capital ratio between 1.5 and 2.0 is often used. However, this value is not universal. It depends heavily on the industry, business model and financing structure.

Limits of the Key Figure

Working capital and the working capital ratio are important figures for financial management. However, they can quickly reach their limits:

• Static balance sheet snapshot

• Seasonality is not taken into account

• Late receipt of receivables remains hidden

• Slow-moving inventories distort the picture

• Booked liquidity is not always available cash

• Missing forward-looking perspective

That is why working capital management should always be combined with liquidity planning. Only cash flow forecasts create transparency over future payment flows. Learn how Financial Navigator’s liquidity planning solution supports finance teams with forward-looking management.

Working Capital Management: The Most Important Levers

To optimise working capital, there are three central levers:

1. Optimising Receivables (DSO): Days Sales Outstanding (DSO) shows how many days a company has to wait on average for its invoices to be paid. To optimise this, shorter payment terms must be set. Existing receivables must also be managed more efficiently.

2. Optimising Inventories (DIO): Days Inventory Outstanding shows how long goods or materials remain in stock on average before they are sold or processed. Improve this figure by defining actual demand. Inventories should reflect actual demand as accurately as possible.

3. Managing Liabilities (DPO): Days Payable Outstanding (DPO) shows how long a company takes on average to pay supplier invoices. A higher DPO means that liquidity stays in the company for longer and can be used for other purposes. However, a good balance should be found. Stretching payment terms too much can put pressure on supplier relationships.

The cash conversion cycle connects all three levers. It measures the period between cash outflows and the return of liquidity. It measures: How many days pass between the purchase of goods and the receipt of money from the customer? This figure therefore connects all three components: DSO, DIO and DPO. The shorter the cash conversion cycle, the more efficiently capital is used.

How a TMS Improves Working Capital Management

Working capital management is only as good as the underlying data. A treasury management system ensures the accurate collection of relevant data. It connects bank data, ERP systems, payment information and forecast data for calculating and optimising working capital. This offers many benefits:

• Fewer manual data exports

• Fewer errors in spreadsheets

• Up-to-date cash transparency

• Better forecast quality

• Central payment controls

• Audit trails and authorisations

• Better decisions on receivables, payment timings and financing needs

With a TMS like Financial Navigator, finance teams can manage working capital, liquidity and payment processes on a central data basis. Request a demo.