working capital ratio

The working capital ratio, also known as the current ratio, is a financial metric that measures a company’s short-term liquidity position. This ratio indicates the company’s ability to cover its short-term liabilities with its short-term assets. The formula to calculate the working capital ratio is:

Working Capital Ratio = Current Assets / Current Liabilities

Where:
– Current assets include cash, cash equivalents, accounts receivable, inventory, marketable securities, and other short-term assets that can be converted into cash within one year.
– Current liabilities include short-term debt, accounts payable, accrued liabilities, and other short-term liabilities that are due within one year.

A ratio of 1.0 is typically considered the middle ground. A ratio less than 1.0 indicates a negative working capital and potential liquidity issues, while a ratio above 1.0 implies that the company can pay off its short-term liabilities with its short-term assets, which is a positive sign of financial health. However, an excessively high ratio may also indicate that the company is not using its assets effectively to generate revenues.

It’s also important to compare a company’s working capital ratio with those of other companies in the same industry, as norms can vary by industry.