TL;DR
Working capital is the cash your business has available to operate day to day. If it's negative or shrinking, you're heading for trouble regardless of what your P&L says.
I ask every new client the same question in our first meeting: "How many days could your business survive if revenue stopped tomorrow?" Most don't know the answer. The ones who do are usually uncomfortable with it.
That number is your working capital expressed in days. It's the most practical measure of your business's financial health, and it matters more than your profit margin. According to the BDC, the average Canadian small business holds about 65 days of working capital. Businesses with fewer than 20 employees often operate with less than 30 days.
The Calculation
Working capital = Current Assets - Current Liabilities. Pull these numbers from your balance sheet.
Current assets include: cash in bank, accounts receivable, inventory, and prepaid expenses. These are things you can convert to cash within 12 months.
Current liabilities include: accounts payable, credit card balances, current portion of loans, HST/GST owing, payroll liabilities, and any other debts due within 12 months.
If your current assets are $280K and your current liabilities are $195K, your working capital is $85K. Divide that by your average daily operating costs (say $3K per day) and you have about 28 days of operating runway. That's tight.
The Current Ratio
Divide current assets by current liabilities. Using our example: $280K / $195K = 1.44. That's below the 1.5 comfort zone. Here's what the ranges mean in practice.
Below 1.0: You can't pay your current bills. This is an emergency. You need either more revenue, less debt, or outside capital. Now.
1.0 to 1.5: Tight. You can pay your bills, but one slow month or unexpected expense puts you at risk. Start working on improvement immediately.
1.5 to 2.0: Healthy. You have a comfortable buffer. Maintain this through disciplined AR collection and expense management.
Above 2.0: Very comfortable. But above 3.0, consider whether you have idle cash that should be invested in growth or returned to owners.
Why Working Capital Erodes
The most common causes I see in client businesses.
Slow collections. Your AR grows faster than your revenue. Customers take longer to pay, but your bills come due on the same schedule. Every day a receivable sits uncollected, it's eating your working capital.
Owner draws. The owner pulls cash out faster than the business generates it. Retained earnings drop, equity shrinks, and working capital follows.
Growth spending. Hiring, inventory, equipment purchases. All necessary for growth, but all consume working capital in the short term.
Seasonal swings. Revenue drops in the slow season but fixed costs don't. If you didn't save during the busy season, working capital takes a hit every year at the same time.
How to Improve Working Capital
- Speed up collections. Tighten payment terms, send invoices immediately, follow up at 7 days. Moving your average collection from 45 to 30 days frees up significant cash.
- Slow down payables (strategically). If a supplier offers Net 45 and you're paying in 15, take the full term. That's 30 days of free cash.
- Reduce inventory. If you carry inventory, audit it. Slow-moving stock is cash sitting on a shelf. Liquidate what isn't selling.
- Establish a line of credit. A line of credit is a working capital safety net. Set it up while your numbers are strong. Draw on it during dips, repay during peaks.
- Manage owner draws. Pay yourself a consistent salary rather than irregular draws. Plan distributions quarterly based on actual cash position, not wishful thinking.
Working Capital and Lending
Banks and lenders look at working capital before almost anything else. A profitable business with declining working capital is a risky loan. A less profitable business with strong, stable working capital is a safer bet. If you're planning to apply for financing, get your working capital trending in the right direction for at least 3 months before you apply.
What to Do This Week
- Pull your balance sheet. Calculate working capital and the current ratio. Write both numbers down.
- Calculate days of operating runway. Working capital divided by your average daily operating costs.
- Compare to 3 months ago. Is working capital growing or shrinking?
- If it's below 1.5 current ratio: identify the biggest drain (slow AR, high draws, debt repayments) and address it this month.
The Bottom Line
Profit means nothing if you can't pay next week's bills. Working capital is the number that tells you whether you can. Monitor it monthly, protect it during growth, and build it during good times so it carries you through the bad ones. If your working capital is tight, book a free call and we'll figure out how to strengthen it.
Next step: run your numbers through the free CFO scorecard.
Frequently Asked Questions
- What is working capital?
- Working capital is current assets minus current liabilities. It represents the cash available to fund daily operations. If it's positive, you can pay your short-term obligations. If it's negative, you may struggle to cover bills even if you're profitable.
- What is a healthy working capital ratio?
- A current ratio (current assets divided by current liabilities) between 1.5 and 2.0 is healthy for most businesses. Below 1.0 means you can't cover short-term obligations. Above 3.0 might mean you have idle cash that could be invested in growth.
- Can a profitable business have negative working capital?
- Yes. If a business has profit tied up in receivables or inventory while current debts are due now, working capital can be negative. This is common in fast-growing businesses where cash is consumed by growth faster than profits generate it.
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