When running a business, you need a clear picture of your company’s financial situation to make sound decisions. You can look at different ratios to figure out where your company sits financially, and one of those is your working capital ratio, which gives you an idea of your company’s liquidity and general financial health.
What Is Working Capital?
Working capital measures how well your company is doing financially by comparing your current assets to your current liabilities. Think of it as an indicator of the amount of cash and liquid assets, or assets, you can quickly convert to cash when you have available to meet your current financial obligations. To calculate your current working capital, take all of your current assets and subtract your current liabilities. Your assets can include cash, accounts receivable, inventory, and any other liquid assets. Liabilities might include your accounts payable, notes payable, or other payable accounts. For example, if a company has $1 million in current assets and $400,000 in current liabilities, the working capital is $600,000.
Calculating the Working Capital Ratio
You can calculate your working capital ratio to help you decide if you have a healthy assets-to-liabilities ratio. The working capital ratio shows whether your company has enough short-term assets to cover your short-term liabilities. To calculate the ratio, divide your current assets by your current liabilities. Continuing the example above, the ratio is:
- $1 million / $400,000 = 2.5
The working capital ratio can give you a quick picture of your financial health. A ratio below 1 shows problems for the company because you have too many liabilities compared to your assets. Higher ratios show a healthier financial state, but a ratio higher than 2 means you may want to consider reinvesting more of your assets back into the company. If you track your working capital ratio over several years, you can look for trends, such as a gradually decreasing working capital, which shows you may need to make changes to improve your financial state.
Using a variety of measurements to track your company’s financial health helps you stay on top of your finances. Cloud-based accounting software makes it easier to track your assets and liabilities for better financial management. 4.3 million customers use QuickBooks. Join them today to help your business thrive for free.