CORPORATE FINANCE & ACCOUNTING FINANCIAL ANALYSIS

How Do You Calculate Working Capital?

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BY RYAN FURHMANN Updated Jun 24, 2019

Working capital represents a company's ability to pay its current liabilities with its current assets.
Working capital is an important measure of financial health since creditors can measure a company's
ability to pay off its debts within a year.

Working capital represents the difference between a firm’s current assets and current liabilities. The
challenge can be determining the proper category for the vast array of assets and liabilities on a
corporate balance sheet and deciphering the overall health of a firm in meeting its short-term
commitments.

Components of Working Capital

Current Assets

This is what a company currently owns—both tangible and intangible—that it can easily turn into cash
within one year or one business cycle, whichever is less. More obvious categories include checking and
savings accounts; highly liquid marketable securities such as stocks, bonds, mutual funds and ETFs;
money market accounts; cash and cash equivalents, accounts receivable, inventory, and other shorter-
term prepaid expenses. Other examples include current assets of discontinued operations and interest
payable. Current assets do not include long-term or illiquid investments such as certain hedge funds, real
estate, or collectibles.

Current Liabilities

In similar fashion, current liabilities include all the debts and expenses the firm expects to pay within a
year or one business cycle, whichever is less. This typically includes all the normal costs of running the
business such as rent, utilities, materials and supplies; interest or principal payments on debt; accounts
payable; accrued liabilities; and accrued income taxes. Other current liabilities include dividends payable,
capital leases due within a year, and long-term debt that is now coming due.

Working Capital

How to Calculate Working Capital

Working capital is calculated by using the current ratio, which is current assets divided by current
liabilities. A ratio above 1 means current assets exceed liabilities, and generally, the higher the ratio, the
better.

\begin{aligned} &\text{Current Ratio}= \frac{\text{Current Assets}}{\text{Current Liabilities}}\\

\end{aligned}

Current Ratio=

Current Liabilities

Current Assets

Working Capital Example: Coca-Cola

For the fiscal year ending December 31, 2017, The Coca-Cola Company (KO) had current assets valued at
$36.54 billion. They included cash and cash equivalents, short-term investments, marketable securities,
accounts receivable, inventories, prepaid expenses, and assets held for sale.

Coca-Cola had current liabilities for the fiscal year ending December 2017 equaling $27.19 billion. The
current liabilities included accounts payable, accrued expenses, loans and notes payable, current
maturities of long-term debt, accrued income taxes, and liabilities held for sale.

According to the information above, the company's current ratio is 1.34:

$36.54 billion ÷ $27.19 billion = 1.34

Does Working Capital Change?

While working capital funds do not expire, the working capital figure does change over time. That's
because a company's current liabilities and current assets are based on a rolling 12-month period.

The exact working capital figure can change every day, depending on the nature of a company's debt.
What was once a long-term liability, such as a 10-year loan, becomes a current liability in the ninth year
when the repayment deadline is less than a year away. Similarly, what was once a long-term asset, such
as real estate or equipment, suddenly becomes a current asset when a buyer is lined up.

Working capital as current assets cannot be depreciated the way long-term, fixed assets are. Certain
working capital, such as inventory and accounts receivable, may lose value or even be written off
sometimes, but how that is recorded does not follow depreciation rules. Working capital as current
assets can only be expensed immediately as one-time costs to match the revenue they help generate in
the period.

While it can't lose its value to depreciation over time, working capital may be devalued when some
assets have to be marked to market. That happens when an asset's price is below its original cost, and
others are not salvageable. Two common examples involve inventory and accounts receivable.

Inventory obsolescence can be a real issue in operations. When that happens, the market for the
inventory has priced it lower than the inventory's initial purchase value as recorded in the accounting
books. To reflect current market conditions and use the lower of cost and market method, a company
marks the inventory down, resulting in a loss of value in working capital.

Some accounts receivable may become uncollectible at some point and have to be totally written off,
which is another loss of value in working capital. As such losses in current assets reduce working capital
below its desired level, it may take longer-term funds or assets to replenish the current-asset shortfall, a
costly way to finance additional working capital.
What Working Capital Means

A healthy business will have ample capacity to pay off its current liabilities with current assets. A higher
ratio of above 1 means a company's assets can be converted into cash at a faster rate. The higher the
ratio, the more likely a company can pay off its short-term liabilities and debt.

A higher ratio also means the company can easily fund its day-to-day operations. The more working
capital a company has means that it may not have to take on debt to fund the growth of its business.

A company with a ratio of less than 1 is considered risky by investors and creditors since it demonstrates
that the company may not be able to cover its debt if needed. A current ratio of less than 1 is known as
negative working capital.

We can see in the chart below that Coca-Cola's working capital, as shown by the current ratio, has
improved steadily over the last few years.

A more stringent ratio is the quick ratio, which measures the proportion of short-term liquidity as
compared to current liabilities. The difference between this and the current ratio is in the numerator,
where the asset side includes cash, marketable securities, and receivables. The quick ratio excludes
inventory, which can be more difficult to turn into cash on a short-term basis.

The value of working capital should be assessed periodically over time to ensure no devaluation occurs,
as continuous operations require enough working capital in place.

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Related Terms

Working Capital (NWC) Definition

Working capital, also known as net working capital (NWC), is a measure of a company's liquidity,
operational efficiency and short-term financial health. more

How the Quick Ratio Works

The quick ratio or acid test is a calculation that measures a company’s ability to meet its short-term
obligations with its most liquid assets. more

How the Current Ratio Works as a Liquidity Ratio

The current ratio is a liquidity ratio that measures a company's ability to cover its short-term obligations
with its current assets. more

What Everyone Needs to Know About Liquidity Ratios

Liquidity ratios are a class of financial metrics used to determine a debtor's ability to pay off current debt
obligations without raising external capital. more

Marketable Securities

Marketable securities are liquid financial instruments that can be quickly converted into cash at a
reasonable price. more

Ciphering the Acid-Test Ratio

The acid-test ratio is a strong indicator of whether a firm has sufficient short-term assets to cover its
immediate liabilities. more

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