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NADefinition
The working capital ratio, also known as the current ratio, measures a company’s ability to meet its short-term liabilities using its short-term assets.
What it means
This ratio indicates the financial health of a business in the near term. It shows whether a company has enough resources, such as cash, receivables and inventory, to cover obligations due within the next 12 months.
A ratio above 1 suggests the business can cover its short-term liabilities, while a ratio below 1 may indicate potential liquidity issues.
How it’s calculated
Working Capital Ratio = Current Assets ÷ Current Liabilities
Current assets typically include cash, accounts receivable and inventory. Current liabilities include obligations such as trade payables, short-term loans and accrued expenses.
Example
If a business has:
- Current assets of $600,000
- Current liabilities of $400,000
The working capital ratio would be:
$600,000 ÷ $400,000 = 1.5
This means the company has $1.50 in short-term assets for every $1.00 of short-term liabilities.
Why the working capital ratio matters
- Helps assess short-term financial stability
- Indicates how efficiently a business manages its working capital
- Used by lenders to evaluate liquidity and creditworthiness
Important to note
A very high ratio may suggest that assets are not being used efficiently, while a very low ratio can signal cash flow pressure.
In practice, the working capital ratio is often analysed alongside other liquidity measures to build a complete picture of a company’s financial position.
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