Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining the proper category for the vast array of assets and liabilities on a firms’ balance sheet and deciphering the overall health of a firm in meeting its shortterm commitments.
Current Assets
Current assets represent assets that a firm expects to turn into cash within one year, or one business cycle, whichever is less. More obvious categories include cash, cash and cash equivalents, accounts receivables, inventory, and other shorterterm prepaid expenses. Other examples include current assets of discontinued operations and interest payable.
Current Liabilities
In similar fashion, current liabilities are liabilities that a firm expects to pay within a year, or one business cycle, whichever is less. Examples include accounts payables, accrued liabilities, and accrued income taxes. Other current liabilities include dividends payable, capital leases due within a year, and longterm debt that is now due within the year.
What Working Capital Means
A healthy business will have ample capacity to pay off its current liabilities with current assets. The current ratio is current assets divided by current liabilities and provides insight into working capital health at a firm. A ratio above 1 means current assets exceed liabilities, and the higher the ratio, the better.
A more stringent ratio is the quick ratio, which measures the proportion of shortterm liquidity as compared to current liabilities. The difference between this and the current ratio is in the numerator, where the asset side includes cash, marketable securities, and receivables. The key item it backs out is inventory, which can be more difficult to turn into cash on a shorterterm basis.
The Bottom Line
The formula for calculating working capital is straightforward, but lends great insight into the shorterterm health of a firm. The quick ratio is an even better indicator of shorterterm liquidity and can be important for suppliers and lenders to understand as well as for investors to assess how a company can handle shortterm obligations.

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