Working capital tells you whether a business has enough short-term assets to cover its short-term obligations. Positive working capital means the business has a cushion. Negative working capital means current liabilities exceed current assets — the business is technically insolvent in the short term, even if profitable.
What goes into working capital
Current assets include cash, accounts receivable, and inventory. Current liabilities include accounts payable, credit card balances, and the current portion of any loans. The ratio of current assets to current liabilities — the current ratio — is a standard measure lenders use to evaluate creditworthiness.
Working capital and the core capital target
Greg Crabtree's Simple Numbers framework addresses working capital through the core capital concept — two months of operating expenses held in reserve before any distributions are taken. Businesses that consistently take distributions before building this reserve are chronically undercapitalized.
Why service businesses often struggle with working capital
Service businesses have fewer current assets than product businesses (no inventory), but often have significant accounts receivable if payment terms are loose. A service business with 60-day receivables and 30-day payables has a working capital problem even if it's profitable.
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