What is working capital and why does it matter?

5 min read

Greenwood Capital
16 April 2026

Working capital is the money your business has available to cover its day-to-day running costs, from payroll and supplier payments to stock and rent. In accounting terms, it’s the difference between your current assets (what you own in the short term) and your current liabilities (what you owe in the short term).

Most business owners have a rough sense of whether cash is tight or comfortable. Working capital puts a number on that feeling. It tells you how much breathing room you have, and whether you could handle a late payment, a quiet month, or an unexpected cost without it becoming a problem.

This guide explains how working capital works, how to calculate yours, what the numbers tell you, and what your options are if things are tighter than they should be.

How do you calculate working capital?

Working capital = current assets – current liabilities.

Current assets are things your business either holds as cash or expects to convert to cash within the next 12 months. That includes money in the bank, unpaid invoices from customers (accounts receivable), stock, and any prepayments you’ve made.

Current liabilities are the bills you need to settle in the same period. Supplier invoices (accounts payable), VAT, PAYE, short-term loan repayments, and any other amounts due within the year.

Subtract one from the other and you’ve got your working capital figure.

For example: Say you run a £2m-turnover electrical contractor. Your balance sheet might look something like this:

Current assets Current liabilities
Cash in bank £85,000 Supplier invoices £95,000
Unpaid customer invoices £140,000 VAT due next quarter £35,000
Stock (cable, switchgear, fittings) £25,000 PAYE and pensions £20,000
Total £250,000 Total £150,000

Working capital: £250,000 – £150,000 = £100,000

That £100,000 is this business’s breathing room – the cash available to cover wages, materials, and overheads while waiting for customers to pay. Whether it’s enough depends on how quickly those payments land. A contractor waiting 60 days on invoices from a main contractor needs more headroom than a business collecting payment on completion.

Our business loan calculator can help you estimate repayments if you’re considering a working capital loan.

What’s a good working capital ratio?

The working capital ratio – also called the current ratio – measures how comfortably your business can cover its short-term liabilities with its short-term assets. You calculate it by dividing current assets by current liabilities.

Working capital ratio = current assets ÷ current liabilities.

Using the example above: £250,000 ÷ £150,000 = 1.67.

A ratio of 1.0 means you have just enough to cover what you owe. Below 1.0 and you’re technically unable to meet your short-term obligations from current assets alone. Most lenders and accountants consider anything between 1.2 and 2.0 to be healthy.

What counts as “good” depends on your sector and how your cash moves. Construction and manufacturing businesses typically sit higher – around 1.7 to 1.85 – because they’re funding materials and labour long before they get paid.

Retailers often operate just above 1.0 because stock turns over quickly and customers pay on the spot. The same ratio can mean very different things depending on your payment terms, your overheads, and how predictable your income is.

It’s also worth remembering that your ratio is only as real as the assets behind it. If a big chunk of your current assets is tied up in invoices that are 60 or 90 days from being paid, that working capital exists on your balance sheet but not in your bank account.

Lenders look at this closely. The working capital ratio is one of the first things an underwriter checks – but they’re reading it alongside your bank statements, your debtor book, and your monthly outgoings.

A healthy ratio with poor cash flow behind it won’t get you far. If your ratio is below where it needs to be, that’s not necessarily a problem. It just means the right type of working capital finance matters more. Invoice finance, short-term working capital loans, or a restructured facility can close the gap quickly.

Warning signs your working capital is under pressure

A working capital ratio can look healthy on paper while the business is already feeling the strain. These are the signs we’d encourage you to watch for:

  • Checking your bank balance before approving routine payments
  • Supplier invoices sitting unpaid past their due dates – not because of disputes, but because the cash isn’t there yet
  • Relying on your overdraft most months rather than occasionally
  • Payroll feeling tight even though revenue is steady
  • Turning down work or delaying a hire because you can’t fund the upfront costs

If your debtor days are creeping up, or a key customer has started paying later, your working capital position is weakening – even if the ratio still looks acceptable. A ratio that’s been falling for two or three quarters shouldn’t be ignored.

How can you improve your working capital?

There are two sides to this: operational changes that free up cash already in the business, and funding that bridges the gap while you sort the underlying issue. Often it’s a combination of both.

Tighten up what you can control

Invoice faster. The gap between completing work and sending the invoice is dead time. Invoice on completion, or at minimum weekly (not at month-end).

Chase what you’re owed. Follow up on day one when an invoice goes overdue. If a customer consistently pays at 60 days on 30-day terms, that needs a direct conversation, not another statement.

Renegotiate supplier terms. If you’re paying suppliers in 14 days but your customers are paying you in 60, your working capital is funding that entire gap. Even moving to 30-day terms frees up cash without changing anything else about how the business operates.

Match the right funding to the problem

The problem What can help
Cash is tied up in unpaid invoices and you’re waiting 30, 60, or 90 days for customers to pay Invoice finance advances up to 90% of the invoice value upfront, so you’re not waiting on your customers to cover your costs
You need to fund materials, wages, or project costs before a contract pays out An unsecured business loan gives you a lump sum to cover the gap, with no collateral required
Cash flow dips between projects or at certain times of year A merchant cash advance repays as a percentage of your daily card sales, so repayments flex with your income
You need equipment to deliver work but can’t afford to buy it outright Hire purchase or asset finance spreads the cost over time, with the asset itself serving as security
You want a larger facility backed by property or business assets A secured business loan offers higher amounts and lower rates in exchange for collateral

If your working capital is tighter than it should be, or you’re not sure which type of funding would help, we can talk it through. Greenwood Capital works with over 100 lenders and can match you with the right option based on your situation. Applying won’t affect your credit score.

Apply now Speak to our team

Frequently asked questions

  • What is negative working capital?

    Negative working capital means your current liabilities are higher than your current assets - you owe more in the short term than you have available to cover it. For most SMEs, this signals that cash flow is under pressure. Some large retailers operate this way by design because they collect from customers before paying suppliers. For smaller businesses, it usually means external funding is needed. Invoice finance or a short-term business loan can help bridge the gap while you stabilise your position.

  • What's the difference between working capital and cash flow?

    Working capital is a snapshot of your financial position at a single point in time - current assets minus current liabilities. Cash flow is the movement of money in and out of your business over a period. You can have positive working capital but poor cash flow if most of your assets are locked up in unpaid invoices or stock. Cash flow tells you more about your day-to-day ability to pay bills on time.

  • What happens if working capital is too low?

    Low working capital limits what your business can do. You may struggle to pay suppliers on time, miss opportunities to take on new work, or rely on expensive short-term borrowing to cover basics like payroll and VAT. If it stays low for too long, it can affect your credit profile and make it harder to access funding when you need it most. If your working capital is consistently tight, explore your options early. We can help you find the right working capital finance for your situation.

  • Can you have too much working capital?

    Yes. An unusually high working capital figure can suggest that cash is sitting idle, stock levels are too high, or invoices aren't being collected efficiently. Lenders and investors sometimes view an excessively high ratio as a sign of inefficiency rather than strength. If a large portion of your current assets is tied up in receivables, invoice finance can convert those into usable cash.

  • Do you have to pay back working capital finance?

    That depends on the type of funding. If your working capital comes from your own cash reserves and retained profits, there's nothing to repay. If you've used external funding, such as a business loan, invoice finance, or an overdraft, then yes, that needs to be repaid according to the terms of the facility. Working capital finance is designed to bridge short-term gaps, not replace revenue.

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