working capital ratio
Working Capital Ratio compares what a business owns and can turn into cash soon against what it owes soon, showing if it can pay its bills without panic.
In plain English
Remember the woman who sells rice and beans at the market, the one who always has change ready before you even ask? She has bags of rice sitting there, money owed to her by regular customers who buy on credit, and cash in her pocket. Against that, she owes her supplier for the last delivery and rent is due on Friday. If what she has coming in easily covers what she owes soon, she sleeps fine. If not, she is borrowing from her sister just to keep the stall open.
That is the whole idea behind the working capital ratio. It takes everything a business can turn into cash within a year, stock, money owed by customers, cash itself, and divides it by everything the business owes within a year, suppliers, short term loans, salaries due. The answer tells you whether the business can cover its near term bills using what it has close at hand.
A Lagos business that imports spare parts might have a ratio of 1.8, meaning for every ₦1 it owes soon, it has ₦1.80 in assets it can convert quickly. That is comfortable. A ratio below 1 means the bills are bigger than the readily available assets, and that business is one delayed customer payment away from serious trouble.
In the United Kingdom, a small building firm might look healthy on paper with strong sales, but if most of that money is tied up in unfinished projects and unpaid invoices, its working capital ratio can still be thin. Profit on paper does not pay the electrician waiting for his cheque.
People sending money home sometimes fund a family business without asking this question first. A shop can look busy and still be starving for cash if everything owed to it is slow to arrive while everything it owes is due now.
A small poultry business has ₦6,000,000 in stock, receivables and cash, and owes ₦3,000,000 in short term debts and supplier bills. Its working capital ratio is 6,000,000 divided by 3,000,000, which equals 2. For every ₦1 owed soon, it has ₦2 available, a sign of reasonable breathing room.
Questions people ask
What is a good working capital ratio?
Most people look for something between 1.5 and 2. Below 1 is a warning sign, and far above 3 can mean cash is sitting idle instead of working for the business.
How is this different from net working capital?
Net working capital is a naira figure, current assets minus current liabilities. The working capital ratio is the same comparison expressed as a division, which makes it easier to compare businesses of different sizes.
Can a profitable business still have a poor working capital ratio?
Yes, easily. A business can show healthy profit on paper while its cash is tied up in unpaid invoices or slow moving stock, leaving it short when actual bills fall due.
Last reviewed