The working capital ratio is a very basic metric of liquidity. It's meant to indicate how capable a company is of meeting its current financial obligations and is a measure of a company's general financial solvency. Companies anꦗd investors look at current assets and current liabilities in determining working capital, also known as net working capital. This information is typically found on a company's balance sheets.

Determining a Good Working Capital Ratio

The working capital ratio is calculated by dividing 澳洲幸运5开奖号码历史查询:current assets by 澳洲幸运5开奖号码历史查询:current liabilities. It is also referred to as the 澳洲幸运5开奖号码历史查询:current ratio.

A working capital rati😼o of less than one is generally taken as indicative of potential future liquidity problems. A ratio of 1.5:2 is interpreted as indicating that a company is on solid financial ground in terms of liquidity.

An increasingly higher ratio above two isn't necessarily better. A substantially higher ratio can indicate that a company isn't doing a good job of employing its assets to generate the maximum possible revenue. A disproportionately high working capital ratio is reflected in an unfavorable 澳洲幸运5开奖号码历史查询:return on assets (ROA) ratio, one of the primary profitability ratios used to🌄 evaluate companies.

What Does the Working Capital Ratio Indicate Abou🍌t Liquidity?

The working capital ratio is a basic measure for assessing a company's financial solvency but it isn't a truly accurate indication of a company's liquidity position. It simply reflects the net result of the total liquidation of assets to satisfy liabilities and this is an event that rarely occurs in the business world. It doesn't reflect additional financing a company may have available such as unused lines of credit.

Companies typically don't access 澳洲幸运5开奖号码历史查询:credit lines for more cash on hand than necessary because this would incur unnecessary interest costs. Operating on such a basis may cause the working capital ratio to appear abnormally low, however. Comparisons of working capital levels over time can nonetheless serve as potential early warning indicators that a company may have problems in terms of timely collection of 澳洲幸运5开奖号码历史查询:receivables. This could lead to future liquidity issues if not ༒addressed.

Measuring Liquidity꧒ Through the Cash Conversi⛎on Cycle

An alternative measurement that might provide a more solid indication of a company's financial solvency is the cash conversion cycle or operating cycle. The cash conversion cycle provides important information on how quickly a company turns over 澳洲幸运5开奖号码历史查询:inventory and converts inventory into paid receivables.

Slow inventory turnover rates or slow collection rates of receivables are often at the heart of cash flow or liquidity problems so 🦩the cash conversion cycle can provide a more precise indication of potential liquidity problems than the working capital ratio.

The Bottom Line

The working capital ratio is a key indicator in evaluating a company's ability to meet its short-term funding obligations. Companies with sufficient working capital are more likely to run their business more efficiently by paying expenses promptly and being able to seize growth opportunities. Investors may consider companies with healthy working capital ratios more attractive given the metric's role in a business's liquidity position, financial performance, and financial management.

Correction—Nov. 30, 2022: This article previously misstated that the working capital ratio appears on the bottom line of a company's balance sheet. It has been edited to note that working capital and the working capital ratio are derived from the current assets and current liabilities figures found on financial statements or balance sheets.