01
The age of the receivables
A ledger where most debt is under thirty days is a very different asset from one where a third is over ninety, and both appear at face value in the total. Ageing is where the quality lives.
Guide
Working capital, calculated and understood.
The formula takes ten seconds. What the answer means takes longer, and the gap between a healthy number and a business that can pay its bills this week is where most of the useful thinking lives.
MS
Matt Stiles Editor
Published 8 September 2026 Last reviewed 8 September 2026 Read time 12 min
The short version
Five lines that cover the concept.
- Working capital is current assets less current liabilities. Both sides mean things due within twelve months, which is what makes it a short-term measure.
- The ratio is the same figures divided rather than subtracted. It makes businesses of different sizes comparable, which the dollar figure does not.
- A healthy number can hide a cash problem. Slow stock and slow debtors are current assets, and neither pays a wage bill on Friday.
- Too high is a problem too. Large working capital frequently means cash trapped in inventory and receivables rather than a business in robust health.
- Indicative only. This is general information rather than accounting advice. How a particular business’s figures are classified is a question for its accountant.
The formula
What goes on each side.
Current assets are the things expected to turn into cash within twelve months. Cash itself, money in the bank, receivables owed by customers, inventory held for sale, and prepayments already made for services not yet received. Anything the business intends to keep and use, such as vehicles, plant or premises, sits outside this.
Current liabilities are the obligations falling due within the same twelve months. Trade payables owed to suppliers, GST and PAYE due to Inland Revenue, wages accrued but not paid, the next twelve months of any term facility, accrued expenses and any revolving facility drawn.
Subtracting the second from the first gives working capital in dollars. Dividing instead gives the current ratio, which is the same information expressed in a way that lets a $2m business be compared with a $20m one. Both are calculated at a moment in time and both change every day.
Current assets
Convert within 12 months
Current liabilities
Due within 12 months
The difference
Working capital
The quotient
The current ratio
A worked balance
A $220,000 position, item by item.
Illustrative figures for a small New Zealand wholesaler. The classification of any particular item is a question for the accountant.
| Current assets | Amount | Current liabilities | Amount |
|---|---|---|---|
| Bank | $35,000 | Trade payables | $180,000 |
| Trade receivables | $290,000 | GST payable | $42,000 |
| Inventory | $210,000 | PAYE and wages accrued | $28,000 |
| Prepayments | $15,000 | Current portion of term debt | $36,000 |
| Revolving facility drawn | $44,000 | ||
| Total current assets | $550,000 | Total current liabilities | $330,000 |
| Working capital | $220,000 | Current ratio | 1.67 |
Illustrative figures on stated assumptions. Not a template for classification, which is a matter for the accountant.
Reading the table
Why $220,000 does not mean $220,000.
The business above has $220,000 of working capital and a current ratio of 1.67, both of which look reasonable. It also has $35,000 in the bank against $28,000 of wages and $42,000 of GST, which means it cannot meet the next month’s obligations from cash.
Everything else on the asset side is receivables and inventory. Those are genuine assets and they will convert, and the question the ratio does not answer is when. Receivables at 55 days and inventory turning three times a year are worth a great deal in six months and nothing at all on Friday.
That is the central limitation of the measure. It is a photograph of a position rather than a description of a flow, and a business managed on the photograph alone will be surprised regularly by the flow. The cash conversion cycle is the companion measure that adds the timing, and it is covered in its own guide.
The components
Four things worth looking at behind the number.
The total is a summary. These are the parts that actually determine whether the position is comfortable.
02
The turn rate on inventory
Stock that turns eight times a year is nearly cash. Stock that turns once is closer to a fixed asset, and carrying it at full value flatters the position considerably.
03
When the liabilities actually fall
Twelve months of obligations lumped together hides whether they fall next week or next November. GST dates and payroll are the ones that arrive regardless.
04
What is drawn on facilities
A drawn revolving facility is a current liability, so drawing on it reduces working capital even though it puts cash in the bank. That surprises people the first time they see it.
Both directions
Too little, and too much.
Too little
The familiar problem.
Negative working capital means current liabilities exceed current assets, so on paper the business cannot meet the next twelve months of obligations from what it expects to convert in that period.
For most businesses that is a warning. For some it is normal and healthy: a supermarket collects cash immediately and pays suppliers in sixty days, which produces negative working capital by design and is a sign of strength rather than weakness.
The distinction is whether the negative figure comes from being paid before paying, which is enviable, or from being unable to pay, which is not. The two look identical in the formula.
Too much
The problem nobody names.
A very high current ratio is frequently presented as strength and is often the opposite. Large receivables mean customers are slow. Large inventory means stock is not moving. Both are cash the business has already spent and cannot use.
A business with a ratio of 3.5 and no cash has locked most of its capital inside its own operating cycle, and the money would do more almost anywhere else.
The useful question is not whether the ratio is high but why. A high ratio driven by cash is genuine strength. A high ratio driven by slow-moving stock is a warning wearing the same clothes.
The one that catches people
Drawing on a facility reduces working capital, even though cash goes up.
Drawing $50,000 on a revolving facility adds $50,000 to the bank and $50,000 to current liabilities, so working capital is unchanged. Drawing to pay a supplier removes the payable and adds the facility drawing, which is also neutral. What changes the figure is trading profitably, converting stock faster or collecting sooner. Borrowing changes the timing of cash rather than the position, which is worth understanding before a facility is presented as a solution to a working capital number.
Improving it
Three levers that actually move the number.
01
Collect sooner
Reducing days sales outstanding converts receivables into cash without changing the total, which improves the quality of the position rather than its size. Prompt invoicing, correct references and an early follow-up are the ordinary mechanics, and they cost nothing. Ten days off a ledger of $290,000 releases roughly $80,000 permanently.
02
Hold less stock
Faster turn releases cash from inventory. It also reduces holding costs, which are frequently larger than the funding cost, and it lowers the risk of writing down a range that stopped selling. The work is in buying more often in smaller quantities and being honest about ranges that do not move.
03
Pay later, within terms
Using the terms a supplier has already granted, rather than paying early out of habit, keeps cash in the business at no cost. Paying beyond terms is a different thing entirely and damages a relationship that is worth more than the days gained.
What lenders do with it
How the figure is read from the outside.
A lender looks at working capital as one input among several, and rarely as a headline. What it does with the figure is check whether the business can meet its short-term obligations, and then look immediately at the composition, because the composition is where the risk sits.
A ratio comfortably above one, built mainly from current receivables and fast-moving stock, reads well. The same ratio built from aged debt and slow inventory reads as a business that has not yet realised it has a problem. Lenders make that distinction routinely and businesses frequently do not.
Some facilities carry covenants expressed against working capital or the current ratio, particularly at larger amounts. Where they do, the definitions used in the covenant matter more than the general concept, and they are worth reading before signing rather than at the first review.
Method
How this guide was written, and its limits.
The formula and the ratio are standard and are not in dispute. What is not standard is how any particular item is classified, which depends on the business, its accounting policies and its reporting framework, and the External Reporting Board publishes the standards that govern it.
Nothing here is accounting or financial advice. This site is not a chartered accountant or a registered financial adviser. Where a specific position is being assessed, particularly against a covenant, the accountant with the figures in front of them is the right person to interpret it.
By business shape
What a healthy position looks like in different businesses.
The same measure produces very different results depending on how a business trades, which is why a single benchmark is worse than none.
| Feature | Retail, cash sales | Wholesale, credit sales | Services, no stock |
|---|---|---|---|
| Inventory | Moderate | Large | None |
| Receivables | Minimal | Large | Large |
| Payables | Large | Moderate | Small |
| Typical working capital | Low or negative | High | Moderate |
| Where the risk sits | Stock that stops selling | Debtors and stock together | Payroll against collection |
| What a low ratio means | Frequently nothing | Ordinarily a warning | Depends on the payroll cycle |
A supermarket with a current ratio below one is operating exactly as intended. A wholesaler with the same ratio is in a materially different position, and the number alone does not distinguish them.
Covenants
When the definition matters more than the concept.
At larger facility sizes, lenders sometimes write covenants expressed against working capital or the current ratio. Where they do, the definition used in the loan document governs rather than the general concept, and the two can differ in ways that matter.
Common differences include whether a drawn revolving facility counts as a current liability, whether related-party balances are included, whether inventory is taken at cost or at a written-down figure, and whether the test is applied at a period end or as an average. Any of those can move a ratio across a threshold without the business changing.
The practical response is to read the definition when the facility is signed rather than at the first test, and to run the calculation as the covenant defines it rather than as the accounts present it. Where the two disagree, the covenant is the one that has consequences.
Frequency
Why the trend is worth more than the figure.
A single reading of working capital is a photograph taken on one day, and businesses that look at it once a year at balance date are looking at the least representative day of the twelve. The month a large tax payment falls, or the month before a seasonal build, produces a figure that says almost nothing about how the business normally sits.
Calculated monthly and plotted, the same measure becomes useful. A ratio drifting down over six months says something a single reading never will, and it says it early enough to act on. The direction is the signal and the level is the context.
The same is true of composition. Watching the proportion of the current asset side that is cash, as against receivables and inventory, catches a deteriorating position months before the headline figure moves, because a business converting stock into aged debt keeps the same total while getting weaker.
A note on the ratio
Why the quick ratio is sometimes the more honest number.
A variant of the current ratio removes inventory from the asset side, on the reasoning that stock is the slowest of the current assets to convert and the least certain in value. What remains is cash, bank and receivables against the same liabilities, which is a stricter test of whether short-term obligations can actually be met.
For a business carrying large or slow-moving inventory the two numbers can differ dramatically, and the gap between them is itself informative. A comfortable current ratio alongside an uncomfortable quick ratio says the position depends on stock selling, which is precisely the assumption worth examining.
Neither figure is the answer on its own. Calculated together and watched over several periods, they show whether a position is improving because the business is converting stock or deteriorating because it is accumulating it, and that distinction is invisible in either number alone.
A common misreading
A rising working capital figure is not automatically good news.
A business whose working capital grew by $80,000 over a year has usually not become $80,000 stronger. The most common cause of an increase in a small business is receivables growing because customers are paying more slowly, or inventory growing because stock is not moving, and both look identical to genuine improvement in the headline figure.
Distinguishing between them takes one further look. Where the increase sits in cash, it is genuine. Where it sits in receivables and the ageing has worsened, the business has converted cash into a slower asset. Where it sits in inventory and turn has fallen, it has converted cash into a slower one again.
That is why the composition question keeps returning on this page. The formula produces a number that behaves the same way whether the business is getting stronger or weaker, and the only thing that separates the two is looking underneath it.
The funding side
What funding a working capital gap costs.
The formula describes the position. This describes what it costs to fund a gap in it. Indicative only, and not a quote or offer of credit.
Indicative interest cost
Weekly
$125/week
$542 /month $6,500 a year while drawn
$100,000
$5,000 $500,000
$50,000
Nothing drawn Fully drawn
13.00% p.a.
8% (secured) 30% (unsecured)
Indicative only. Not a quote or offer of credit. Actual rates, fees, and repayments depend on the business profile and the lender's decision.
Sending to Prospa
Your $100,000 scenario
$50,000 drawn at 13.00% . Prospa will ask a few quick questions, then provide a firm quote and funding if eligible.
Redirecting…
References
Sources
- External Reporting Board
The publisher of the New Zealand accounting standards governing how current assets and liabilities are classified.
- Inland Revenue, GST
The published source for GST as a current liability with fixed due dates.
- Inland Revenue, employer obligations
The published source for PAYE and payroll obligations included on the liability side.
- Stats NZ
Context for New Zealand business balance sheet and payment patterns.
- Chartered Accountants Australia and New Zealand
Referenced for the point that classification and covenant interpretation belong with a chartered accountant.
FAQ
Questions, answered
What is working capital?
Current assets less current liabilities, where both mean items expected to convert or fall due within twelve months. It measures whether a business can meet its short-term obligations from its short-term resources.
What is the current ratio?
Current assets divided by current liabilities rather than subtracted. It expresses the same relationship in a way that allows businesses of different sizes to be compared, which the dollar figure does not.
What is a good current ratio?
It varies enormously by sector, and the composition matters more than the number. A ratio of 1.5 built from current receivables and fast-moving stock is stronger than a ratio of 2.5 built from aged debt and slow inventory.
Can working capital be healthy while cash is short?
Routinely. Receivables and inventory are current assets and neither pays wages on Friday. That gap between the position and the flow is the main limitation of the measure and the reason the cash conversion cycle exists.
Is negative working capital always bad?
No. A business that collects cash immediately and pays suppliers in sixty days produces negative working capital by design, which is a sign of strength. The question is whether it arises from being paid before paying or from being unable to pay.
Can working capital be too high?
Yes, and it is frequently presented as strength. A high figure driven by slow receivables and slow stock is cash locked inside the operating cycle rather than robust health, and the money would do more almost anywhere else.
Does borrowing improve working capital?
Not by itself. Drawing on a facility adds cash and adds a current liability of the same amount, so the figure is unchanged. What moves it is trading profitably, collecting sooner or holding less stock.
Where does a term loan sit?
The portion due within the next twelve months is a current liability and the remainder is not. That split means taking a longer-term facility reduces the current portion, which improves the ratio without changing what is owed.
How often should it be calculated?
Monthly is commonly enough, and the trend matters more than any single reading. A ratio drifting down over six months says something a single month never will.
Do lenders use it?
As one input among several, and they look at composition immediately afterwards. Some facilities carry covenants expressed against it, in which case the definition used in the covenant matters more than the general concept.
What is the quickest way to improve it?
Collecting sooner. Ten days off a receivables ledger releases real cash without changing the total, improving the quality of the position, and the mechanics are prompt invoicing and early follow-up rather than anything financial.
Is this guide accounting advice?
No. It explains a standard measure in general terms. This site is not a chartered accountant or a registered financial adviser, and how a particular business’s items are classified is a question for its accountant.
Related
Keep reading
The working capital cycle
The timing this measure leaves out.
Read onWorking capital calculator
The formula, worked on your own figures.
Read onAll eight products
What funds a gap once it has been measured.
Read onBridging a late-paying debtor
The receivables side, in practice.
Read onWhat lenders assess
How this figure is read from the outside.
Read on