Working Capital Ratio

Both sides come off your balance sheet. Current assets are cash, receivables and inventory: things expected to become cash inside twelve months. Current liabilities are accounts payable, accrued payroll and taxes, and the portion of any debt due inside twelve months. Divide the first by the second and you have the ratio. Subtract instead of dividing and you have working capital itself, the dollar cushion, which what working capital actually is covers in full.

Work an invented balance sheet: $70,000 of current assets against $40,000 of current liabilities gives a ratio of 1.75. In that invented example the business has $1.75 of near-term resources for every dollar of near-term obligation, which is a reasonable cushion. The same business with $45,000 of current assets against $40,000 of liabilities would show 1.13 and a far thinner margin for a late-paying customer.

A ratio below 1.0 means the next year's obligations exceed the resources on hand to meet them, which is the quantitative version of the knot in your stomach. It does not mean the business is failing, because incoming revenue is not on the balance sheet, but it does mean the timing of everything matters. A ratio well above 2.0 can mean the opposite problem: cash and inventory sitting idle that could be earning, or receivables nobody is chasing.

For your file, this is one of the numbers bank and SBA underwriters read when financial statements are part of the application, and it is a fair proxy for whether an owner is watching their own books. It is also worth watching yourself, because the ratio is what tells you whether a shortfall is a timing problem or a structural one. Map the next ninety days in the cash flow gap calculator and the answer usually becomes obvious.

Its main limitation is that it treats every current asset as equally liquid, and they are not. Inventory that moves slowly and a receivable from a customer who is ninety days late are both counted at full value here, which can flatter a business that is genuinely tight on cash. Read the ratio alongside your aging report and your actual bank balance, not instead of them, and check that the underlying figures come from real statements rather than memory. Understanding your profit and loss statement covers the companion document.

The confusion to clear is that this is not the debt service coverage ratio. The working capital ratio is a snapshot of the balance sheet at one moment; DSCR measures income against debt payments across a period. A business can look comfortable on one and strained on the other, and lenders read both because each answers a question the other cannot.