Guide · 4 min
Working capital ratio explained: what yours says about your business
One number tells you whether your business can cover the bills due in the next twelve months. Here is how to work it out, what a healthy result looks like, and what to do when it is tight.
Your working capital ratio compares what your business owns that will turn into cash within a year with what it owes over the same period. It is one of the first numbers an accountant, a supplier or a lender looks at, because it answers a simple question: if every short-term bill fell due tomorrow, could you pay it?
How to calculate your working capital ratio
The formula uses two lines from your balance sheet, which most accounting software will produce in a few clicks.
- Current assets: cash at bank, money customers owe you, stock you expect to sell and prepayments
- Current liabilities: money you owe suppliers, GST and PAYG due, wages and super owing, and loan repayments due within twelve months
- Working capital ratio = current assets ÷ current liabilities
Take a joinery business with $180,000 of current assets: $40,000 in the bank, $95,000 owed by builders and $45,000 of timber and hardware in stock. Its current liabilities are $120,000. The ratio is 180,000 ÷ 120,000, or 1.5. For every dollar due in the next year, the business holds $1.50 in assets that should turn into cash.
Run the numbers at the end of each month and compare them with the same point last quarter. The trend tells you more than any single result.
What a healthy working capital ratio looks like
There is no single right number, and it varies by industry. As a rough guide:
- Below 1.0: short-term bills are larger than short-term assets, so some will be paid from money that has not arrived yet
- Between 1.2 and 2.0: generally comfortable for most trading businesses
- Well above 2.0: comfortable, but there may be cash or stock sitting idle that could work harder
A cafe paid on the day, with little stock on hand, can run safely on a lower ratio than a wholesaler carrying three months of inventory. Compare your result with businesses like yours, and with your own history.
The ratio tells you whether you can pay. Your cash flow tells you when.
Why the ratio can mislead
Not every asset turns into cash on time
A ratio of 1.5 looks safe until you notice that most of it is customers who pay in 60 days, while your biggest bills fall due in 14. The ratio is a snapshot of the balance sheet. It says nothing about timing, which is why it belongs next to a cash flow forecast, not instead of one.
Stock is not cash
Slow-moving or seasonal stock inflates current assets. If you would struggle to sell it at full value this quarter, the quick ratio gives a more honest view: current assets minus stock, divided by current liabilities.
How to improve a tight working capital ratio
- Collect faster: invoice on completion, shorten terms for new customers and follow up overdue accounts weekly
- Hold less stock: reorder closer to demand and clear slow lines
- Negotiate supplier terms: 30 or 45 days instead of 14 changes the timing without changing the cost
- Match funding to the need: long-lived assets such as vehicles usually suit a longer term than short-term working capital
Where short-term finance fits
When the ratio is tight because of timing rather than trading losses, short-term working capital can bridge the gap: a large order to fill, a seasonal build-up, or a big customer on 60-day terms. GreyRok lends $5,000 to $500,000 over 3 to 12 months, with the total repayable agreed before you sign.
If the ratio is tight because the business is losing money month after month, a loan will not fix that, and it can make the problem bigger. Our article on why we say no explains how we tell the difference.
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Check my eligibilityWhat is a good working capital ratio for a small business?
Generally between 1.2 and 2.0, but it depends on your industry. Businesses paid upfront can run lower, while those carrying stock or offering long customer terms usually need more.
Is a working capital ratio below 1 always bad?
Not always, but it means short-term bills exceed short-term assets, so you are relying on future takings to pay them. Watch the timing closely.
How often should I calculate it?
Monthly is enough for most small businesses. Track the trend rather than any single month.
What is the difference between the working capital ratio and the quick ratio?
The quick ratio leaves stock out of current assets, so it shows how well you can cover short-term bills without selling inventory.
This article is general information only and does not take into account your circumstances. GreyRok provides finance to businesses for business purposes only, subject to credit assessment and eligibility criteria.
See if GreyRok is right for your business.
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