Managing working capital effectively is a top priority for businesses, as it ensures you have sufficient cash available to operate efficiently, meet key obligations and respond to market changes, without taking on too much debt or running into financial difficulties.

In this article, we discuss the main things you need to know about working capital, how it works and how to keep a healthy balance.

What is working capital, and why does it matter?

Working capital is the available liquidity your company has to maintain good cash flow levels, fund operational needs and keep up with various financial commitments. In the simplest terms, it’s what you have in assets and cash, minus what you owe, which is a key indicator of your financial health.

It’s essential to regularly monitor your working capital position to ensure you have the right balance, in terms of a positive or negative working capital. 

If you find yourself regularly operating with a negative working capital, it’s a sign you’re either spending too much or making too little. It can lead to cash flow problems, which have knock-on effects on your company’s ability to operate efficiently, pay its bills, meet tax obligations and cover salaries and supplier payments, which also impacts your reputation. 

On the flip side, if you’re always operating with a very positive working capital, this can mean you’re not maximising your spending power – you could be acquiring key assets or new talent, or investing in future growth opportunities. 

What are the different sources of working capital?

There are numerous sources of working capital, from those generated from within the business (think asset sales, profits, cost savings, etc.) to external sources of working capital, be it from finance providers or credit from suppliers.

Below, we’ve outlined both common internal and external sources of working capital for businesses:

Internal sources of working capital

• Internal injection of cash – money made available to business operations from owners.
• Collection of receivables from owed invoices and debts.
• Retained earnings – the profits made that remain available rather than being distributed as dividends.
• Sale of assets no longer required (equipment, machinery, property, etc.).
• Operational cost savings, such as negotiating better supplier agreements, discounted products/services or reducing staff head count.
• Inventory held that’s to be sold in the near future.

External sources of working capital

• Bank overdrafts or other lines of credit to cover temporary cash flow gaps.
• Short-term loans or lending facilities (from banks or alternative lenders) to fund operational needs.
• Advanced payments (from customers or via invoice discounting or factoring).
• Trade credit – agreements with suppliers to delay/stagger payments for goods or services.
• Shares/debentures – issuing shares or debentures as ways to raise capital. 

How to calculate working capital

The basic formula for calculating working capital is as follows:

Working capital = current assets - current liabilities.

The larger the figure, the more liquidity you have available. It’s also important to note that this figure can be positive or negative, according to the balance. 

Calculating your working capital ratio

Working capital is often monitored as a ratio. This is simply calculated by dividing assets by liabilities, rather than subtracting. So, the formula to work out your working capital ratio is as follows:

Working capital = current assets ÷ current liabilities.

Understanding the working capital ratio

The working capital ratio is a key financial metric for indicating your company's ability to meet short-term obligations with its current assets. Essentially, it shows whether you’re in a position to pay your bills and upcoming costs with the assets you have over a certain period. 

While you generally want to have a positive working capital ratio, you don’t want it to be too high, as it may reflect excess cash, idle assets or overstocking, meaning either tied up liquidity or overly conservative spending that can stunt growth.

Also, a continued negative working capital ratio means your current liabilities consistently exceed your current assets, which is a major warning sign. It could mean you have poor inventory management, you’re overextending credit to customers or slow at collecting receivables or over-relying on business finance facilities. This is a looming risk of operational disruption, penalties from HMRC for late tax payments or damaging supplier relationships. 

Note: You may hear working capital (and the ratio) referred to as net working capital (or net working capital ratio), as it’s a calculation that is ‘net’ of liabilities. So they’re essentially the same, as opposed to looking at gross working capital, which is just the total current assets.  

What is a good working capital ratio?

A working capital ratio of between 1.2 and 2.0 is generally considered healthy. Ratios below 1.0 can be a sign of potential liquidity problems, while an overly high ratio indicates your business is not using its assets efficiently to support business growth and key investments.

What constitutes a good working capital ratio can vary, depending on your industry, how you business operates (say, if you have typically longer sales cycles), so look into industry benchmarks to get an idea of the ideal ratio range.

Working capital ratio examples

Let’s use some examples to demonstrate the working capital ratio in action, comparing a scenario of two different companies – in this case, referred to as Company A and Company B:

• Company A has current assets of £1.5 million and debts of £0.5 million.
• Company B has current assets of £6 million and debts of £5 million.

Working through the working capital formula (subtraction), we see that both businesses have the same amount of working capital: £1 million.

However, when using these same totals but applying the working capital ratio formula (division), we see a big difference, which reveals potential issues for Company A:

Company A has a ratio of 3.0, while Company B has a ratio of 1.2.

This extra level of detail with the working capital ratio tells us more about the way the business might be running. Let’s compare the situation for both companies:

• Company A has plenty of cash to pay the coming year’s debts, but could it make better use of all that spare cash, say, to fund expansion, invest in new assets or generate a higher return?
• Company B’s financial position is more finely balanced – while it’s still in the positive, a sudden drop in sales or some unexpected expenses in the coming months could tip the scales and cause potential cash flow concerns.

Learn more about this in iwoca’s dedicated article about the workng capital ratio. 

Other working capital metrics to consider monitoring

There are several other working capital metrics to be aware of, which can give you more specific insights into different aspects of your working capital position, such as available cash, inventory and payables and receivables. 

Here are some other key working capital metrics to keep an eye on:

• Quick ratio: Also known as the acid-test ratio, this liquidity measure excludes inventory (and other assets that aren’t easy to convert into cash) from the calculation, and therefore it’s more conservative.
• Inventory turnover ratio: This indicates how efficiently you’re selling and replenishing inventory by calculating the average number of days, based on turnover across a certain period.
• Days sales outstanding (DSO): Shows the average number of days it takes to collect payment from customers/clients after a sale – lowering this number is crucial for good cash flow management. 
• Days payable outstanding (DPO): Going in the opposite direction to DSO, DPO calculates the average number of days it takes your company to pay its bills and invoices from suppliers.
• Cash conversion cycle (CCC): This is a holistic metric that measures how long your cash is tied up in operations (in inventory, sales and payables), helping you to monitor increasing or decreasing operational efficiency. 
• Working capital turnover: This measures how working capital is being put to use, specifically how effective you are at generating revenue from your working capital. 

Explore Investopia’s dedicated pages on the above metrics for an in-depth view of each and how to calculate and monitor them.

It’s also worth considering non-cash working capital, which represents your company’s working capital minus any cash and cash equivalents. This essentially compares your accounts receivable, inventory and prepaid expenses with your accounts payable and accrued liabilities.

How to interpret changes in your working capital ratio

It’s important to remember that your working capital balance and working capital ratio are snapshots in time, representing your position and projecting 12 months into the future. And while it gives you a good idea of your financial health for the current accounting period, comparing it against previous periods provides additional perspective. 

For example, a ratio of 1.1 takes on an entirely different meaning if previous years were between 0.7 and 0.9 versus a five-year run from 2.9 to 2.0. Take a look at the visual below:

‍The first example of changes in working capital (the red line) suggests a business is addressing cash flow issues and improving working capital management. The second example (the blue line) suggests decreasing operational efficiency, perhaps sales in decline, or escalating running costs and debts that are rising faster than revenue.

This is why it’s important to monitor working capital, look at changes to the ratio and identify trends and reasons for the shift in the figure. 

How to manage your working capital

Working capital management is one of the biggest challenges for SMEs, especially smaller businesses. Rising business costs, economic factors and new tax obligations are making conditions tough. According to SME research from Simply Business, one in five small businesses fear they could be forced to close permanently if conditions don’t improve.

As mentioned, cash flow and working capital are closely linked. By keeping track of your working capital regularly, you can ensure you have the available cash and flexibility to adapt to changes in your market, whilst using insights to analyse how efficiently you’re running the business.

Key questions to ask when managing working capital

• How long does it take to turn inventory into revenue?
• Are my customers paying on time?
• Am I turning my investments into growth in a timely manner?
• Is the business effectively managing our payables to optimise cash flow without damaging supplier relationships?
• Do we have enough liquidity to cover short-term financial obligations in slow sales periods or when incurring unexpected costs?
• Do we have excess inventory that’s tying up cash that could be reinvested?
• Are we using available credit facilities efficiently, and are there other sources of external working capital we can explore?

Shorten your working capital cycle

The working capital cycle measures the time it takes a business to convert its net working capital into cash. This varies from business to business and sector to sector, so compare your working capital cycle with industry norms. This will give you a marker to look at when seeking to improve working capital management.

Key ways to improve your working capital 

There are various ways to address working capital issues and shorten your working capital cycle. Here are 6 key actions you can take to manage working capital effectively and achieve a healthier balance:

1. Optimise inventory levels – by minimising excess stock and adopting just-in-time (JIT) practices, you can reduce waste, which frees up cash.
2. Seek to extend payables – if you can negotiate longer payment terms with suppliers (without harming relationships), you can ease cash flow pressure.
3. Accelerate receivables collection – consider using automation to improve collection efficiency and trigger chaser messages or tighten credit policies to encourage prompt client payments.
4. Closely monitor cash flow – track cash flow trends and use cash flow forecasting to anticipate and address shortfalls.
5. Implement expense controls – monitor expenses and identify inefficiencies to see where you can reduce unnecessary costs.
6. Use short-term business finance – explore working capital finance options to support operational needs, when required, and plug cash flow gaps.

How to finance working capital shortages and cash flow gaps

There are various finance options available to UK businesses seeking to address working capital needs, which can provide crucial liquidity to fund key areas of the business, ongoing, and plug cash flow gaps in key periods.

Iwoca’s SME Index research from early 2025 revealed 41% of brokers said the most requested reason for applying for unsecured finance was to manage day-to-day cash flow. 

Here are some of the main working capital finance options to consider:

• Working capital loans: Short-term business loans, often unsecured, with affordable monthly repayments, plus interest, to use for operational needs.
• Lines of credit: A revolving finance facility that allows you to draw down funds, as and when required, and repay in instalments, before topping up.  
• Business overdrafts: A buffer-style credit limit to dip into when you have temporary cash flow shortages and need to meet financial obligations. 
• Invoice finance: An advance of pending client invoices to unlock upcoming capital to cover bills or make time-sensitive purchases. 
• Merchant cash advances: A form of revenue-based finance that allows you to borrow a lump sum in exchange for a percentage of future card sales.
• Trade credit: An agreement with suppliers to receive goods or services in advance with deferred or longer future payment cycles.  

Working capital loans and other short-term finance solutions offer fast access to additional funds to cover bills, plug cash flow gaps and invest in inventory or other assets in periods when you otherwise wouldn’t have the flexibility to do so.

Using a flexible working capital loan to help your business grow

Iwoca is a leading business loan provider for UK SMEs, helping businesses to manage cash flow and balance working capital, offering flexibility and scope to invest in future growth and fund expansion plans.

We designed our iwoca Flexi-Loan for small businesses, providing fast access to funds and flexible repayments, tailored to your needs. You can use our loan like a line of credit, drawing down funds when required and only paying interest on what you use. Plus, we don’t charge for early repayment.  

You can borrow from £1,000 to £1 million for a few days, weeks or up to 60 months. Expect funding decisions in 24 hours, with successful applicants often accessing funds on the same day. 

Find out how to get a business loan with iwoca or use our handy loan calculator to work out your likely repayments. 

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Working capital FAQs

We’ve outlined a few common questions about working capital and answers which can help you with queries you may have:

What is the difference between cash flow and working capital?

While closely linked, cash flow and working capital are distinctly different. Working capital is the liquidity available to cover operational costs and short-term obligations, calculated as the difference between current assets and liabilities. Cash flow is the movement of money in and out of the business over a set period. Both are influenced by factors like market conditions, seasonality and business models and sales periods, with working capital directly affecting cash flow.

What is the difference between working capital and net working capital?

There is technically no difference between working capital and net working capital. The phrases are essentially interchangeable, as working capital calculations are ‘net’ of liabilities. Gross working capital is the total value of all current assets, without considering any liabilities. 

What are considered current assets and liabilities in working capital terms?

Current assets are anything the company expects to be converted into cash, sold or used up within an operating cycle (typically 12 months), including accounts receivable, inventory or equipment to be sold and prepaid expenses. Current liabilities are your obligations, such as accounts payable, tax obligations, short-term loans and debts and accrued expenses, due within the same period .

What are working capital loans?

 A working capital loan is a type of short-term loan that is used specifically for day-to-day and periodic operational needs. It’s a way to get fast access to additional capital to ease cash flow concerns and cover liabilities, from payroll to tax bills, while offering breathing space for making purchases that fuel growth. 

They are usually unsecured loans, with slightly higher interest rates than secured loans, with repayments made monthly or weekly, depending on the borrowing period.