Working capital is the amount of an entity's current assets minus its current liabilities. The result is considered a prime measure of the short-term liquidity of an organization. A strongly positive working capital balance indicates robust financial strength, while negative working capital is considered an indicator of impending bankruptcy.
A 2:1 ratio of current assets to current liabilities is considered healthy, though the ratio can vary by industry. The ratio may also be reviewed on a trend line, with the intent of spotting any declines or sudden drops that could indicate liquidity problems.
As an example of the calculation of working capital, a business has $100,000 of accounts receivable, $40,000 of inventory, and $35,000 of accounts payable. Its working capital is:
$140,000 Current assets - $35,000 Current liabilities = $105,000 Working capital