How is working capital calculated?

Working capital is calculated by subtracting current liabilities from current assets. This measurement is key to assessing a company's short-term financial health and operational efficiency. Current assets include items that can be quickly converted into cash within one year, such as cash, inventory, and accounts receivable. Current liabilities, on the other hand, are obligations the company needs to settle within the same timeframe, including accounts payable and short-term debt.

The formula, current assets minus current liabilities, provides a clear picture of the liquidity available to a business. A positive working capital indicates that the company can cover its short-term debts with its short-term assets, suggesting healthy financial stability. Conversely, if current liabilities exceed current assets, it could signal potential liquidity issues.

In contrast, adding current assets to current liabilities does not provide useful or accurate information regarding the company’s financial health—this approach would inaccurately combine the assets and liabilities without reflecting the net available resources. Similarly, total assets minus total liabilities gives a measure of the net worth or equity of the company, and dividing non-current assets by current liabilities does not yield any relevant insights into working capital. Thus, the method of subtracting current liabilities from current assets is the appropriate calculation for determining working capital.