Working Capital: The Number Your Bank Looks At That Most Owners Ignore

When a bank reviews your business for a line of credit or loan, working capital is one of the first numbers they calculate.

Most business owners have no idea what their working capital position is. They know their bank balance and their revenue. They do not know the ratio that determines whether a bank will extend them credit or whether their business can absorb a slow month without a crisis.

What Working Capital Is

Working capital is the difference between your current assets and your current liabilities.

Formula: Current Assets minus Current Liabilities.

Current assets are things that will convert to cash within 12 months: cash in the bank, accounts receivable (money owed to you), and inventory.

Current liabilities are obligations due within 12 months: accounts payable (money you owe suppliers), credit card balances, short-term loans, and any portion of long-term debt due within the year.

If you have $200,000 in current assets and $120,000 in current liabilities, your working capital is $80,000. This means you have $80,000 more in short-term resources than short-term obligations.

The Working Capital Ratio

Banks typically look at the ratio rather than the absolute number: Current Assets divided by Current Liabilities.

A ratio of 1.0 means your current assets exactly cover your current liabilities. No cushion. A ratio below 1.0 means you have more short-term obligations than short-term resources. This is negative working capital, and it is a significant red flag to lenders.

Most lenders want to see a ratio of at least 1.2 to 1.5. Higher is better, but very high ratios (above 3.0) can indicate that you are holding too much cash or inventory without deploying it productively.

For most service businesses, the working capital ratio is driven primarily by the relationship between accounts receivable and accounts payable. If you collect from clients in 45 days but pay your suppliers in 30 days, your working capital is being compressed. If you collect in 30 days and pay in 45, it is expanding.

Why It Matters Beyond Bank Lending

Working capital is not just a metric for loan applications. It is a direct measure of short-term financial health.

Negative or declining working capital means your business is consuming liquidity faster than it is generating it. You may be profitable on the P&L and still be burning through reserves because your current liabilities are growing faster than your current assets.

This happens in growing businesses that take on more work than their cash cycle can support. You spend money delivering work before you get paid for it. As you grow, this gap widens. A business can be profitable, growing, and technically insolvent at the same time because it has run out of working capital.

This is why banks ask about working capital before asking about profitability. Profit is backward-looking. Working capital tells them whether your business can meet its obligations over the next 12 months.

How to Improve Your Working Capital Position

Accelerate receivables collection. Every day you shorten your average collection time adds working capital. Moving from net 30 to net 15 terms, requiring deposits on new work, and following up on overdue invoices all improve the current assets side of the equation.

Extend payables terms. If you are paying suppliers on net 15 when they offer net 30, you are giving away working capital. Use the full payment terms available to you. Do not prepay unless there is a meaningful discount attached (2% or more for paying within 10 days is generally worth it; 0.5% is not).

Reduce inventory if applicable. Carrying excess inventory ties up working capital. Review your inventory turnover ratio quarterly. If you are holding 90 days of inventory when 30 days would cover demand, the excess is working capital sitting on a shelf.

Establish a line of credit before you need it. A revolving line of credit is the working capital buffer that smooths the gap between spending and collecting. Apply for it when your balance sheet is strong, not when you are already under pressure. Banks approve credit to businesses that do not immediately need it. They are cautious about businesses that desperately need it.

Checking Your Position

Pull your Balance Sheet from QuickBooks or Xero. Your current assets and current liabilities are the top sections. Calculate working capital and the working capital ratio. If you have not looked at this number in the last 90 days, do it today.

If your ratio is below 1.2, it is worth understanding why before a lender or cash crunch forces the question. If you want to walk through your Balance Sheet and understand your working capital position, book a call.

Next step: run your numbers through the free CFO scorecard.