You can get a sense of where you stand right now by determining your working capital ratio, a measurement of your company’s short-term financial health.

 

Working capital formula:
Current assets / Current liabilities = Working capital ratio

 

If you have current assets of $1 million and current liabilities of $500,000, your working capital ratio is 2:1. That would generally be considered a healthy ratio, but in some industries or kinds of businesses, a ratio as low as 1.2:1 may be adequate.

 

Your net working capital tells you how much money you have readily available to meet current expenses.

 

Net working capital formula:
Current assets – Current liabilities = Net working capital

 

For these calculations, consider only short-term assets such as the cash in your business account and the accounts receivable — the money your customers owe you — and the inventory you expect to convert to cash within 12 months.

 

Short-term liabilities include accounts payable — money you owe vendors and other creditors — as well as other debts and accrued expenses for salary, taxes and other outlays.

 

Working capital that is in line with or higher than the industry average for a company of comparable size is generally considered acceptable. Low working capital may indicate a risk of distress or default.

Getting a true understanding of your working capital needs may involve plotting month-by-month inflows and outflows for your business. A landscaping company, for example, might find that its revenues spike in the spring, then cash flow is relatively steady through October before dropping almost to zero in late fall and winter. Yet on the other side of the ledger, the business may have many expenses that continue throughout the year,

 

Parts of these calculations could require making educated guesses about the future. While you can be guided by historical results, you’ll also need to factor in new contracts you expect to sign or the possible loss of important customers. It can be particularly challenging to make accurate projections if your company is growing rapidly.

 

These projections can help you identify months when you have more money going out than coming in, and when that cash flow gap is widest.