Supply Chain Finance

How to Calculate Working Capital Requirements: a quick start guide for AP

Calculating Working Capital Requirements

During periods of crisis and uncertainty, cash is king. That’s why every business is laser focused on their working capital needs right now.

Accounts payable is core to these efforts. Its work has a direct impact on the balance sheet and the company’s overall working capital strategy.

Yet we often hear that accounts payable teams feel they have little input into the working capital optimization strategy. Instead, their role is simply to act on the instructions handed down to them—and deal with the mess created when sellers aren’t paid on time.

This is a missed opportunity. The department can provide treasury with crucial inputs into the total value of outstanding invoices. It helps control the flow of outgoing payments. And it can engage with suppliers to smooth any issues when payment dates are missed or terms extended.

It’s time accounts payable played a bigger role in determining the working capital strategy of the organization. To help you get started, here’s a refresher on exactly what working capital is and how it’s calculated.

How to calculate working capital requirements

Working capital is a measure of how effectively a business can manage its short-term financial obligations. It’s understood by finding the difference between a company’s short-term liquid assets and its current liabilities.


Working capital = current assets – current liabilities

Current assets are items such as: 

  • Property
  • Cash in the bank
  • Inventory
  • Accounts receivables.

While liabilities usually refer to:

  • Salary obligations
  • Accounts payable
  • Leases
  • Taxes

Although working capital metrics fluctuate daily most businesses will assess the number on a six or 12 month rolling basis.

Positive working capital 

Working capital is a key indicator of the financial health of a company. And, generally speaking, the CFO, CEO and investors will want the business to operate with positive working capital—meaning their assets are greater than liabilities.

This means the business can convert its assets into cash quickly to meet its short-term needs and also cover any unexpected expenses that  arise.

Yet it’s not quite as straightforward as that. Companies whose working capital ratio is very high may have operational issues. For instance, they may be sitting on lots of inventory they cannot shift. Or maybe they’re hoarding cash rather than investing it into R&D and business growth—something that happened in many businesses following the 2008/9 financial crisis.

Negative working capital 

When a company has negative working capital, that usually means that they’ll need to turn to short-term financing to plug the gap and ensure they can pay the bills. This isn’t necessarily an issue for large businesses who have easy access to multiple forms of credit. But it can be fatal for SMEs, who often pay a premium to access short-term working capital funding.

There are some exceptions to that rule. Apple, for example, is arguably the world’s most financially sound company, yet it operates with negative working capital. But that’s because it has strong bargaining power with suppliers, can quickly collect cash or advances from customers when it needs to, and has sound management of their inventory.

Industry nuances 

To complicate matters further, ideal working capital metrics often differ from industry to industry and are dictated by its operating cycle. Retail for instance requires high levels of working capital because it must stock lots of inventory and cannot guarantee that it will sell to pay the bills.

Technology firms, on the other hand, require much less working capital, especially when it’s primarily delivering software services. Therefore a very high working capital ratio in a technology company may indicate that it’s not investing enough money into R&D.

It’s time to optimize working capital

Calculating the working capital ratio can provide some useful insights into the health of the business and whether it has the financial means to cover it’s short-term liabilities. But, as we’ve seen, it’s not a straightforward equation and there are many nuances that must be accounted for.

Yet it’s a number that every business must focus on. And accounts payable has a big role to  play in optimizing working capital.

See how Tradeshift Cash can optimize working capital for your business

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