Net working capital: What it is and how to calculate it
- What is net working capital?
- Net working capital vs. gross working capital
- What's included in net working capital?
- How to calculate net working capital
- What is a good net working capital ratio?
- Limitations of net working capital
- Net working capital examples
- How to improve your net working capital
- Improve your working capital with Ramp
Net working capital is the simplest gauge of whether your business can cover what it owes over the next year. It's the gap between your current assets, like cash and receivables, and your current liabilities, like payables and short-term debt.
A positive number doesn't always mean you're healthy, and a negative one doesn't always mean trouble. What matters is understanding where that number comes from and what it says about your cash flow.
What is net working capital?
Net working capital is the money you have available to run your business day to day, after accounting for everything you owe in the next 12 months. Understanding it clearly is the foundation for making smarter decisions about cash, debt, and growth. The formula to calculate it is:
Net working capital = Current assets − Current liabilities
Net working capital (NWC) represents the difference between current assets (such as cash, inventory, and accounts receivable) and current liabilities (such as accounts payable and short-term debt). In simple terms, net working capital represents the funds available for day-to-day operations. Effective working capital management drives revenue growth, cash flow, customer service and shareholder value.
Net working capital vs. gross working capital
Gross working capital counts only what you own in the short term. Net working capital nets out what you owe, so it tells you far more about your actual liquidity.
Working capital, also known as gross working capital, is a financial metric that represents the operating liquidity available to a business. It's a measure of a company's short-term financial health and its ability to cover its short-term obligations.
Working capital only considers the value of your business's current assets. This can be misleading as it doesn't pay attention at all to what your business owes in the short term. In contrast, net working capital considers both current assets and current liabilities in its calculation, which gives a more complete picture of your business's short-term health.
| Gross working capital | Net working capital | |
|---|---|---|
| What it measures | The short-term resources you have on hand | Your ability to cover short-term obligations with those resources |
| Formula | Current assets | Current assets − current liabilities |
| What it misses | Everything you owe in the next 12 months | Timing and quality of assets, such as stale inventory or uncollectible AR |
Net working capital example
To further illustrate the difference, let's say your business has $750,000 of cash in the bank and has bills due that are worth $800,000.
If your business was just looking at gross working capital, you'd only look at your assets and see that you have a positive gross working capital of $750,000. Based on that, you may think everything is great because there's a bunch of cash in the bank.
But, if you considered net working capital instead, you'd look at your cash compared to what you owed. In this case, you'd have a real reason to worry since you'd owe more than you have in the bank.
Gross working capital still has its place as a quick check, but net working capital is the number worth tracking.
What's included in net working capital?
Net working capital comes down to two buckets on your balance sheet. Here's what sits in each one, and why the distinction changes how you read the number.
Current assets
Your current assets are the short-term resources you can convert to cash, meaning you expect to collect or sell them within the next 12 months.
- Cash
- Inventory
- Prepaid expenses
- Marketable securities
- Accounts receivable (AR)
Current assets are assets that can be converted to cash within the year. These are your cash inflows.
Current liabilities
Your current liabilities are everything you're on the hook to pay in the short term.
- Short-term debt
- Accounts payable (AP)
- Accrued expenses
- Deferred revenue
Current liabilities are liabilities that are due within the year. These are your cash outflows. You can find both your current assets and current liabilities on your cash flow statement and balance sheet.
Sales, costs, and, therefore, profits don't always coincide with your cash inflows and cash outflows, which is why understanding working capital is so important.
Having enough net working capital means having the ability to pay bills, understanding when to seize opportunities to grow, and having enough of a buffer or contingency fund to keep your business running.
How to calculate net working capital
Working capital management is a balancing act between controlling expenses and optimizing revenue collection. You can calculate net working capital using this formula:
Net working capital = Current assets – Current liabilities
Pull both figures from the current sections of your balance sheet as of the same date. Three steps get you to the number.
1. Total your current assets
Add up every asset you expect to convert to cash within 12 months:
- Cash and cash equivalents
- Accounts receivable
- Inventory
- Prepaid expenses
- Marketable securities
2. Total your current liabilities
Add up every obligation due within 12 months:
- Accounts payable
- Short-term debt
- Accrued expenses
- Deferred revenue
3. Subtract current liabilities from current assets
Take your liabilities total out of your assets total, and what's left is your net working capital.
Using the earlier example:
$750,000 in current assets − $800,000 in current liabilities = −$50,000 in net working capital
You're $50,000 short of what you owe over the next year, so you'd need incoming collections, a longer payment runway from suppliers, or financing to close the gap.
What is a good net working capital ratio?
Most businesses should aim for a working capital ratio of 1.5 to 2.0. That means holding $1.50 to $2.00 in current assets for every $1.00 you owe short term.
A useful measure of this balancing act is your working capital ratio. Also called the current ratio, you can calculate a more practical version of your working capital using this formula:
Working capital ratio = Current assets / Current liabilities
This metric gives you a snapshot into your company's liquidity and its ability to meet short-term financial obligations. A positive working capital ratio indicates that you have enough resources to cover your short-term expenses, while a negative working capital may signal potential cash flow issues.
Generally, it's recommended that you aim for a working capital ratio of 1.5 to 2.0. Anything higher than a 2.0 suggests you aren't optimizing your ROI on assets and revenue. Anything less than 1.5 is a red flag that you may not be able to pay your short-term payables and payroll.
Here's what each range tends to signal:
- Below 1.0: You owe more in the short term than you can cover. Treat this as a liquidity risk that needs attention now.
- 1.0 to 1.5: You can technically cover your obligations, but the cushion is thin. One late customer payment can create a crunch.
- 1.5 to 2.0: You have a healthy buffer for bills, payroll, and surprises. This is the range most businesses should target.
- Above 2.0: You're likely sitting on assets that aren't working hard enough. Look at whether cash or inventory could be redeployed.
What counts as "good" also shifts by industry. Inventory-heavy retailers often carry higher ratios because so much value sits in stock, while service businesses with fast collections can run comfortably leaner.
Limitations of net working capital
The working capital ratio or current ratio has limitations depending on the context within which it's calculated. If you operate a business with high seasonality, the current ratio might not offer the best picture of your liquidity. That's often why it might be better to use the cash conversion cycle or even the quick ratio (or acid test) instead.
Your quick ratio excludes your inventory from the working capital ratio:
Quick Ratio = (Current assets – Inventory) / Current liabilities
Include your most collectible AR
Only include your most collectible accounts receivable in the quick ratio. Anything over 90 days may not be collectible and could cause you to overestimate cash flow.
Another limitation of NWC is that it counts all inventory in the assets value. If your business holds a lot of inventory then that will inflate your asset value, which increases your NWC value.
But if most of your NWC value is from old inventory that you can't really sell for cash, then you may not be able to pay your bills or cover payroll despite a positive NWC. This is why your quick ratio may paint a more accurate picture for lenders or management.
Net working capital examples
Net working capital rarely reads as cleanly as the formula suggests. These two scenarios show why a negative number can be fine and a positive one can hide a problem.
When negative net working capital can still be healthy
The relevance of NWC may depend on your business model and your cash conversion cycle (CCC). There are cases where a business might have a negative working capital but is, in fact, financially healthy.
For example, an eCommerce company that makes a sale online and gets payment up front never has accounts receivable and generates a lot of cash. Having a fast CCC like this is the best-case scenario.
If this company decides to distribute cash to owners as well, they may experience a scenario where their current assets are low, but they may still have AP on a 30-day term. This can make their NWC look negative, but because they're receiving cash right away, their business will be able to generate more cash before their bills are due.
This is often the case with grocery stores and restaurants. In both examples, they get paid in cash at the time of sale, but they typically get about 30 days to pay their suppliers, and they pay their payroll every 2 weeks in arrears.
When positive net working capital isn't a good sign
In most cases, you'd assume a positive working capital is a good thing. That's not always the case.
Because people often pay their lawyers last, law firms frequently have large outstanding accounts receivable. This inflates their current assets, but the equally large salaries they pay their team don't show up in liabilities. So even though a law firm may have a positive working capital, in this case all it indicates is that they're doing a terrible job of collecting invoices.
A positive net working capital that's a result of just holding on to old inventory is another scenario where the company isn't in good financial standing.
How to improve your net working capital
Improving net working capital comes down to pulling cash in faster and pushing obligations out further. Five levers do most of the work.
1. Increase sales to new customers
Add new customers to reduce the negative effect of churn. Growth on the top line lifts collections, which lifts your current assets. Pairing that with low-cost customer acquisition strategies can make each new dollar of revenue go even farther.
2. Replace short-term debt with long-term debt
Shift short-term obligations into longer-term debt so you can defer your debt payments until the business generates more cash. That moves the balance out of your current liabilities.
3. Optimize production
Optimize production to avoid idle employees and equipment. That increases your manufacturing throughput and builds up inventory for your fastest turning items.
4. Lower monthly expenses
Lower monthly expenses to increase cash balances and lower payables. Ramp Business Banking's Cash Manager automatically sweeps excess operating cash into an advised Investment Account⁴ and pulls it back to Checking¹ as bills come due. That way, your operating cash keeps earning until the day you need it.
5. Shorten your billing cycle
Shorten your billing and cash conversion cycles: Collect a larger up-front fee or do more progress-billing rather than just invoicing in arrears after all the project work is completed. Getting paid earlier in the delivery cycle keeps cash in your account instead of your receivables.
There are real benefits to improving your net working capital, but it shouldn't be your sole measure of liquidity given its limitations. Set a baseline for your business model and track the number against it over time, alongside your quick ratio and cash conversion cycle.
Improve your working capital with Ramp
Not all lenders keep up with how modern businesses operate. Ramp offers commerce sales-based underwriting to give growing companies access to flexible working capital when traditional loans fall short.
Traditional underwriting focuses on cash on hand as the main indicator of business health. That doesn't always fit how modern businesses run, especially inventory-based operations. Ramp's commerce sales-based underwriting lets your access to working capital grow with your sales volume.
Ramp also goes beyond financing by offering spend management tools that show exactly where borrowed funds are going. With your spending centralized, you can make data-driven decisions on where to cut costs or reinvest in growth.
If your long-term plans include taking out loans or credit lines with traditional institutions, Ramp can help you build business credit along the way. Building credit early helps secure better terms as your company scales.
Try an interactive demo to see how Ramp helps you manage working capital and control spending in real time.
¹ Ramp Business Corporation is a financial technology company and is not a bank. Bank deposit services provided by First Internet Bank of Indiana, Member FDIC.
⁴ Investment account with portfolios managed by Moment Advisors, LLC. Investing involves risk, including possible loss of principal. Asset allocation does not guarantee profit or protect against loss. Past performance does not guarantee future results. Additional information can be found here. Securities products offered by Apex Clearing Corporation, member FINRA, SIPC. The Investment Account is not insured by the FDIC, not a deposit product, and may lose value.
FAQs
Net working capital is the difference between your current assets and your current liabilities. It shows how much money you have available to run day-to-day operations after covering everything you owe within the next 12 months.
Subtract your current liabilities from your current assets: Net working capital = Current assets − Current liabilities. Both figures come from the current sections of your balance sheet on the same date.
A high net working capital usually means you can comfortably cover short-term obligations, which is good. Push it too high, though, and it can signal that cash or inventory is sitting idle instead of earning a return.
Aim for a working capital ratio between 1.5 and 2.0. Below 1.5 suggests you may struggle to cover payables and payroll, while above 2.0 suggests your assets aren't being put to work.
Gross working capital counts only your current assets, so it ignores what you owe in the short term. Net working capital subtracts current liabilities, which gives you a more complete view of your short-term financial health.
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