Working Capital is the fund required to run the day to day operations of the company. It is an indicator of the financial health and short-term liquidity needs for the company.

Working Capital = Current Assets – Current Liabilities

Current Liabilities

Current Assets

Accounts Payable


Accounts Receivable


Short Term Debt




Other Current Liabilities






Current Investments




Other Current Assets






Working Capital





Current assets are assets which can be converted to cash within 12 months and current liabilities are liabilities due within 12 months. A positive working capital shows financial strength whereas a negative working capital indicate a possibility of cash crunch or impending business trouble. Negative working capital can be a business strategy employed by a few companies which we will discuss in detail subsequently.

A standard ratio of 2:1 of current assets vs current liabilities is considered as a healthy balance sheet, though the ideal ratio varies from industry to industry. As a good business practice, companies should track working capital religiously so as to not be blindsided by a cash crunch and to account for unforeseen events. There are ways that a company can fund working capital and manage the liquidity by careful tracking of its assets and liabilities.


Working Capital Cycle

Working Capital Cycle or the Cash Conversion Cycle is the time it takes to convert the current assets and liabilities to cash. It shows the time it takes to sell the inventory, collect cash from customers and pay the vendors/suppliers respectively. The longer the cycle, the longer the time the funds are blocked without earning any return on capital. The company should always try to optimize the working capital cycle by shortening the cycle which would lead to business efficiency and unlocking the capital.

Cash Conversion Cycle = Days of Sales Outstanding + Days of Inventory Outstanding – Days of Payable Outstanding


Figure 1 : Cash Conversion Cycle



Figure 2 : Cash Conversion Cycle Waterfall Chart

Days of Sales Outstanding (DSO) represents number of days the company takes to collect cash from debtors. Days of Inventory Outstanding (DIO) is the number of days it takes to sell the inventory. Days of Payable Outstanding (DPO) is the number of days it takes to pay the company’s creditors. Ideally, DSO and DIO should be short since longer the number of days, longer it takes the company to receive cash and DPO should be long since longer the number of days, longer you keep the cash within the company.

Investment heavy companies manufacturing companies like cement and steel may have a long cash conversion cycle. Cash businesses like ecommerce companies, restaurants, groceries etc usually enjoy a negative working capital cycle with high turnover.

An ideal working capital cycle would be a negative cash cycle. It indicates that the company can sell and collect money from the customers before it has to pay its suppliers. A negative cycle could mean that the company need not borrow to fund any shortfall. The company can achieve a negative cash cycle by taking advances/shorter payment terms to customers, selling inventory faster or taking a longer credit period from the suppliers. HUL and Amazon are two companies known to have a negative conversion cycle.


Figure 3 : Negative Working Capital Cycle Waterfall Chart

In the subsequent article, we will cover more practical cases to optimize working capital and how to fund the working capital gap.