Working Capital: Definition, Calculation & Optimization

Key takeaways

• Definition: Working capital (net working capital) is the difference between current assets and current liabilities.
• Formula: Working capital = current assets − current liabilities. A positive value means that current assets exceed current liabilities.‍
• Benchmark: A working capital ratio of 100% or more means that current liabilities are covered; around 130% to 200% is often considered healthy. Values vary depending on the source and industry. The rule is: optimize rather than maximize, because too much tied-up capital costs you returns.‍
• Benchmark: In the German mid-market, the median cash conversion cycle is around 55 days, with an average optimization potential of about 12.5% of revenue (Grant Thornton, 2023).‍
• Levers: Inventory, receivables, and payables. Managing these shortens the cash conversion cycle and frees up liquidity.‍
• Looking ahead: Working capital is a snapshot in time. Only when combined with rolling liquidity planning does it become clear how your decisions will affect future solvency.

What is working capital: simply explained

In short: Working capital (net working capital) is current assets minus current liabilities. This figure shows how much short-term capital is tied up in day-to-day operations and whether your company can pay its current bills on its own.

To make this figure tangible, it is worth looking at its two components.

Current assets and current liabilities

Current assets include all assets that can normally be converted into cash within one year: bank balances and cash on hand, outstanding trade receivables, as well as inventory and stock.

Current liabilities include everything that falls due within one year:

• Accounts payable to suppliers,
• short-term bank loans and overdraft facilities, as well as
• outstanding tax and payroll obligations.

Why working capital is so important for SMEs

Working capital is the bridge between the balance sheet and everyday business. It determines whether wages, rent, and supplier invoices can be paid on time without the need for expensive short-term financing. This is relevant because the average equity ratio in the mid-market is only 30.7% (KfW-Mittelstandspanel, 2025) and 43% of companies rate their financial situation as problematic (DIHK, 2025).

On the positive side: Healthy working capital gives you room to maneuver. You can take advantage of early payment discounts, invest in growth, and negotiate with suppliers and banks from a position of strength. Our guide on calculating liquidity shows how to determine your overall solvency.

How do you calculate working capital?

In short: You calculate working capital using a simple formula: current assets - current liabilities.

Additionally, the working capital ratio shows the relationship between the two figures as a percentage. You can find both values directly in your balance sheet or management report.

The working capital formula

As mentioned, the basic formula is very simple:

A positive result means that your current assets exceed your current liabilities. A negative result means that your current liabilities are greater than your current assets.

Calculation example for an SME

Take a trading company with the following balance sheet items:

The working capital is 60,000 euros. This means the company could fully cover its short-term debt using its current assets and would still have a buffer.

Calculating the working capital ratio and working capital margin

The absolute euro value alone says little about the scale. That is why you put it into perspective. Two key figures are commonly used for this (Deutsche Bank, n.d.):

• Working capital ratio: current assets ÷ current liabilities × 100.

→ In the example: 150,000 ÷ 90,000 × 100 = approximately 167%.

• Working capital margin: working capital ÷ current assets × 100.

→ In the example: 60,000 ÷ 150,000 × 100 = 40%.

The working capital ratio is the most common form. It corresponds to the current ratio and shows the percentage of short-term debt covered by current assets. We will clarify what constitutes a healthy value below.

What is the difference between working capital and net working capital?

In short: In most German sources, net working capital means the same thing as working capital, i.e., current assets minus current liabilities (Gabler Wirtschaftslexikon, n.d.). Only in a narrower interpretation does operating net working capital focus exclusively on the core business.

Net working capital = current assets − current liabilities

However, there is a narrower, more precise business interpretation. Operating net working capital excludes items that are not part of the core business, such as bank balances and short-term financial liabilities:

This variant shows how much capital is tied up solely in the operating cycle of purchasing, inventory, sales, and payment terms. It is often more informative for managing day-to-day business than the broad definition. The important thing is that you always use the same definition when making comparisons.

Is high or low working capital good?

Positive working capital is generally considered a good sign because it means a company can cover its short-term debt on its own. However, it should not be too high.

If it is permanently negative, it can be a warning sign because short-term debt is not covered by short-term assets.

However, very high working capital is not automatically better. It can mean that too much money is tied up in full warehouses and long customer payment terms.

This capital is then tied up and is not available for investments or debt reduction. This is precisely the profitability trap that professional sources warn about (Deutsche Bank, n.d.).

Read our article Avoiding Liquidity Bottlenecks to learn how to take early countermeasures when things get tight.

What does negative working capital mean?

Negative working capital typically means that current liabilities exceed current assets. This can be an indicator of liquidity problems.

However, the business model is the deciding factor:

A retailer that collects payments immediately via cash or card but only pays for its goods 30 to 60 days later is effectively financing its operations through its suppliers. In this case, negative working capital is a sign of efficiency, not financial distress.

In industries with long lead times, such as manufacturing or project-based businesses, persistent negative working capital is risky. In these cases, there is no buffer to pre-finance wages and materials before customer payments are received. Whether a negative value is good or bad can therefore only be assessed within the context of the specific industry.

How high should working capital be? Guidelines and industry benchmarks

As a rough guideline, a working capital ratio between 100% and 200% is considered healthy (Creditreform, 2025). However, the ideal value depends heavily on the industry: retail and e-commerce often operate with very low or negative working capital, whereas manufacturing and project-based businesses tie up significantly more capital.

• A working capital ratio above 100% means that current assets exceed current liabilities (Creditreform, 2025).
• A range of approximately 130% to 200% is often considered comfortable (Controllingportal, n.d.).
• Values significantly above 200%, on the other hand, often indicate excessive inventory or slow incoming payments (Creditreform, 2025).
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Guideline: A working capital ratio of 100% or more means current liabilities are covered; around 130% to 200% is often considered healthy. These values vary depending on the source and industry. The rule of thumb is to optimize rather than maximize, as too much tied-up capital reduces returns.

Comparing your figures to industry standards is more meaningful than relying on a rigid percentage. The following overview shows typical patterns:

A study on German SMEs shows just how much is at stake in practice:

The median cash conversion cycle is around 55 days, with an average optimization potential of approximately 12.5% of revenue (Grant Thornton, 2023).

For 10 million euros in revenue, this mathematically represents around 1.25 million euros in liquidity that could be freed up through better working capital management.

What is the cash conversion cycle and how does it relate to working capital?

In short: The cash conversion cycle combines three key figures: DIO (days inventory outstanding, derived from inventory turnover), DSO (days sales outstanding, or your customers' payment duration), and DPO (days payable outstanding, or your own payment duration). The formula is: DIO + DSO − DPO. The lower the value, the faster tied-up capital is converted back into cash.

The cash conversion cycle measures in days how long capital is tied up in operational business from the moment of purchase until it is back in the account after the sale. It adds a time dimension to working capital.

In other words: Working capital is a snapshot in time. The cash conversion cycle (CCC) turns this into a time-based metric, showing how quickly tied-up capital is converted back into cash.

The rule is: The shorter the cycle, the less capital you need to finance the same volume of business (Controllingportal, n.d.).

The cash conversion cycle consists of three components:

• DIO (Days Inventory Outstanding): how long goods remain in stock on average.
• DSO (Days Sales Outstanding): how long it takes customers on average to pay invoices.
• DPO (Days Payables Outstanding): how long you take to pay your own suppliers.

A calculation example based on our trading company (annual revenue €600,000, cost of goods sold €360,000):

At 42 days, the example company is below the median for small and medium-sized enterprises.
Every day you shorten the cycle frees up capital. This is exactly where optimization comes in.

What is Working Capital Management?

In short: Working Capital Management is the active management of inventory, receivables, and payables with the goal of tying up as little capital as possible and keeping the cash conversion cycle short. It turns a static balance sheet figure into an ongoing management task (Creditreform, 2025).

While the working capital figure only reflects a single reporting date, working capital management is a continuous process. It integrates purchasing, warehousing, sales, and financial accounting in such a way that tied-up capital is converted back into liquidity as quickly as possible.

The goal is not to minimize working capital, but to optimize it: maintaining enough of a buffer to remain capable of paying and delivering at all times, while keeping dead capital to a minimum.

The effect is immediate: Every day you shorten the cash conversion cycle frees up tied-up capital that you can use for investments, early payment discounts, or reducing expensive debt.

This makes working capital management less about window dressing and more about a genuine financing lever you can pull yourself.

Specifically, working capital management focuses on three levers, which we will look at in detail in the next section: inventory, receivables, and payables.

How can you optimize your working capital?

You can optimize working capital using three levers:

• Reducing inventory,
• collecting receivables faster, and
• fairly extending payment terms with suppliers.

The goal is not maximum working capital, but optimal working capital: enough of a buffer for security, but as little tied-up capital as possible (Creditreform, 2025).

Optimizing inventory

Reduce slow-moving items and excess stock, streamline your product range, and work with demand-based procurement where possible. Faster inventory turnover lowers DIO and thus the cash conversion cycle without compromising your ability to deliver.

Actively managing receivables

Issue invoices immediately after service delivery, agree on clear payment terms, and offer early payment discounts as an incentive for prompt payment. A credit check before taking on larger orders reduces the risk of default. Every day less in DSO shortens the cycle immediately.

Managing payables and purchasing

Negotiate fair, longer payment terms with suppliers and bundle purchases to achieve better conditions. The balance is key: skipping early payment discounts just to extend payment terms rarely pays off, as discounts are usually the cheaper form of financing.

Financing Working Capital

Where operational levers are not enough, financing instruments bridge short-term capital requirements. The most common options are:

• Current account or operating credit line: a flexible credit line from the bank that cushions short-term gaps between outgoing and incoming payments. Factoring: You sell outstanding invoices to a service provider and receive immediate liquidity instead of waiting for your customers to pay. This also lowers your DSO. Supplier financing (reverse factoring): a financial partner settles your supplier invoices immediately, while you pay back later. This effectively extends your payment terms (DPO) without straining the supplier relationship. Inventory financing: a financier pays for your inventory in advance, allowing you to build up stock without immediately tying up your own capital.

These instruments provide breathing room in the short term, but they do not address the operational root cause. Therefore, the rule is: optimize processes first, then finance strategically.

PRACTICAL EXAMPLE

An agency with an average payment period of 60 days switches to immediate invoicing upon project completion and offers a 2% discount for payment within 10 days. The DSO drops to around 35 days. With an annual turnover of 1.2 million euros, this corresponds to around 82,000 euros that are no longer permanently tied up in outstanding receivables, but are instead available for salaries and growth.

Working Capital and Liquidity Planning: Why Looking Ahead Is Decisive

Working capital is a snapshot in time and looks backward. For management purposes, you also need to look ahead!

This is how your working capital directly impacts your operating cash flow: every euro you free up from inventory and receivables strengthens your cash flow and your room for maneuver.

Rolling liquidity planning shows how changes in inventory, payment terms, or receivables affect your future solvency before things get tight.

Why is this important? The working capital metric does not tell you what your account balance will look like in eight weeks if you extend supplier terms today or if a major customer pays late. It is precisely this impact that you make visible with liquidity planning.

In software like Tidely, you connect your bank accounts and accounting system so that receivables, payables, and inventory flow into your forecast in real time.

Using scenario analysis, you can simulate in just a few clicks how a longer payment term, inventory reduction, or delayed payment receipt will affect your liquidity (best, base, and worst case). This turns a retrospective metric into a forward-looking management tool.

The article Liquidity Management shows what structured liquidity control looks like in everyday business.

Test Tidely for 7 days for free and see in real time how your working capital decisions affect future liquidity. No credit card required, first forecast in just a few minutes. Start for free now

Conclusion

Working capital shows how well your company can cover its short-term obligations on its own. The formula is simple, but the art lies in the balance: enough buffer for security, as little tied-up capital as possible. Those who actively manage inventory, receivables, and payables and combine this metric with forward-looking liquidity planning transform working capital from a balance sheet figure into a real growth lever.

Frequently Asked Questions About Working Capital

What exactly is working capital?

Working capital is the difference between a company's current assets and its current liabilities. It indicates how much short-term capital is tied up in day-to-day operations and whether a company can pay its current bills on its own.

How do you calculate working capital?

You can calculate working capital using the formula: current assets minus current liabilities. For example, if current assets are 150,000 euros and current liabilities are 90,000 euros, the resulting working capital is 60,000 euros. You can find both values directly on the balance sheet.

Is high or low working capital good?

Positive working capital is generally good because it means the company can cover its short-term debts. However, it shouldn't be too high, as that would mean too much capital is tied up in inventory and receivables, which could be used for more profitable purposes. The ideal is a balance—essentially: optimize rather than maximize.

What is Working Capital Management?

Working capital management is the ongoing control of inventory, receivables, and payables. The goal is to achieve the shortest possible cash conversion cycle and minimize tied-up capital without compromising the ability to deliver or pay.

What is the difference between net working capital and working capital?

In practice, both terms are usually used synonymously to mean current assets minus current liabilities. In a narrower definition, operating net working capital considers only the core business—i.e., receivables plus inventory minus trade payables—and excludes cash and financial debt.

What does working capital indicate?

Working capital indicates how stable a company's short-term financing is. A positive value means that current assets exceed current liabilities, providing a liquidity buffer. It also serves as an early warning indicator: declining working capital can point to rising inventory levels or sluggish payments.

What is a good working capital ratio?

At 100 percent, short-term debts are covered by current assets (Creditreform, 2025). Depending on the source, a range of around 130 to 200 percent is considered healthy (Controllingportal, n.d.). It is calculated by dividing current assets by current liabilities and multiplying by 100. Values significantly above 200 percent often indicate excessive inventory; the ideal value depends on the industry.

How can you improve working capital quickly?

The fastest way to improve working capital is to collect outstanding receivables promptly, reduce excess inventory, and negotiate fair, longer payment terms with suppliers. Together, these measures shorten the cash conversion cycle and free up tied-up capital. Financing instruments like factoring can bridge additional short-term needs.

Sources

1. Sparkasse: Working Capital, 2026

2. Gabler Wirtschaftslexikon: Working Capital, n.d.

3. KfW: KfW-Mittelstandspanel, 2025

4. DIHK: DIHK Economic Survey Early Summer 2025, 2025

5. Deutsche Bank: Working Capital. How to keep an eye on your liquidity, n.d.

6. Allianz Trade: Working Capital. Definition and significance, n.d.

7. Creditreform: Working Capital Management, 2025

8. Grant Thornton: Working Capital in German SMEs, 2023

9. Controllingportal: Working Capital. Explanation and example calculation, n.d.

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