What's a working capital ratio?

A working capital ratio measures your ability to pay off bills and repayments within the next 12 months.

Working capital ratio formula

To calculate the working capital ratio, you need to divide current assets by current liabilities: 

Working capital ratio = current assets/current liabilities

Current assets: These are assets that you expect to convert into cash or use up within the next 12 months. Current assets can include:

• Cash
• Accounts receivable
• Inventory
• Prepaid expenses
  
  

Current liabilities: These are obligations that you need to pay off within the next 12 months. Current liabilities can include:

• Wages
• Expenses
• Accounts payable
• Short-term debt

For example, if you have $300,000 in current assets and $150,000 in current liabilities, your working capital ratio would be: 300,000/ 150,000 = 2

What’s a good working capital ratio?

Working capital ratio below 1: A ratio less than 1.0 indicates you may have trouble covering your costs, as your liabilities are larger than your assets

Working capital ratio between 1 and 2: A ratio between 1 and 2 is generally considered acceptable and suggests that you can reasonably cover your costs

Working capital ratio above 2: A ratio above 2.0 typically indicates strong short-term financial health, as you have more than twice the amount of current assets needed to cover your current liabilities. However, an excessively high ratio might also mean you aren’t efficiently utilising your assets, potentially leading to missed investment opportunities or overstocking of inventory.

What a working capital ratio means for businesses

Operational efficiency: By monitoring this ratio, you can identify and adjust inefficiencies in how you manage your receivables, payables, and inventory.

Creditworthiness: Lenders and investors often look at the working capital ratio to evaluate a company’s financial health. A strong ratio might improve your chances of securing loans or attracting investment.