Working capital continues to go under-examined by most small businesses. But if you know how much cash you need to run the business and then assess how efficiently you deploy this cash, you can start to make smarter, more informed decisions that support and boost growth. 

Although it sounds daunting, working out your working capital isn’t overly complicated. In fact, most of the numbers you need are already on your balance sheet.

Let’s dive in. 

What is working capital? 

Your company’s working capital is the cash required to run the business: assets minus liabilities. That includes inventory, paying staff, rent, utilities, tools and other necessities. What’s left over is profit to invest in new growth initiatives or save for a rainy day. 

Most accountants want to ensure working capital remains positive - that you have more assets than debts. That said, growing businesses can use negative working capital to generate net cash by selling assets faster than they repay liabilities. Gymshark is a great example of this. 

Unlike most of the metrics on this list, working capital is expressed in pounds, dollars, euros, or whichever currency you prefer. It’s not a ratio - it’s the literal cash and assets you have on hand to run your business. 

Why track working capital? 

Working capital isn’t just a measure of financial health, it’s a tool SMBs can use to function efficiently. You can intentionally increase working capital when you know you want to invest heavily or decrease it by paying off debts early.

Let’s look at a few ways to measure working capital efficiency.

9 valuable working capital metrics

Here are nine working capital metrics that might be helpful for you to explore. The first four are considered crucial - table stakes for any small business hoping to grow or sustain itself efficiently. 

The remaining five are interesting if you want to go further and get more advanced with working capital–companies with larger and more stable balance sheets may get real insight from applying some of these. 

1. Days sales outstanding (DSO)

How long is the period between a sale taking place and you receiving the cash? This ultimately depends on your payment terms.

Do you require partial payment in advance? Do you offer a one-month turnaround, or perhaps three months? 

You also need to chase overdue invoices effectively. These are a fact of doing business and reducing your DSO may require you to re-evaluate your collections process. 

A consistently high DSO - above industry averages - suggests your processes are inefficient and it’s taking too long to receive payments.

To work out your DSO, use this formula: 

DSO = (accounts receivable/net credit sales) x number of days

For example:

If your company made £10 million in sales in the past 12 months and you have £2 million outstanding in accounts receivable, your DSO would be (2,000,00010,000,000) x 365 = 73 days

Whether that’s high or not depends on your industry and your own expectations. But shortening it can’t hurt.

Don’t forget that individual months or seasons can skew your DSO in the short term. For example, if you have an excellent month of sales, you’ll naturally have more outstanding accounts receivable than usual. This is a good thing. If you can clear those within a reasonable amount of time, you’ve done well. But until you do, your DSO will be higher than normal. 

2. Days payables outstanding (DPO)

Conversely to DSO, this is the average amount of time it takes to pay your bills. How you manage and optimise this period can create real financial opportunities. 

In general, you want to pay on time,but not early–paying early reduces your working capital because you no longer have the cash.

The longer you can wait to pay suppliers, the more cash you have available–a high DPO is often a good thing.  

On the other hand, your DPO could be high simply because you can’t afford to pay suppliers. This, of course, is not a good place to be. 

For some business owners, it’s safer and less stressful to pay as soon as possible. Push payments too far down the track and you can end up paying late fees or incurring more debt than you’re comfortable with. 

If you want to optimise working capital, the goal is a DPO that’s higher than your DSO. 

You can work out your DPO using this formula:

DPO = (average accounts payable/cost of goods sold (COGS)) x 365

For example: 

To generate your £10 million in sales in the past 12 months, you needed to spend £5 million overall - this is your COGS.

If your starting accounts payable balance was £1.5 million and your AP balance ended at £1 million, then your average accounts payable for the year is £1.25 million.

Therefore, your DPO would be: (1,250,000/5,000,000) x 365 = 91 days. 

91 is a fairly long DPO. In this example, either you’ve negotiated favourable payment terms with your suppliers, or you may be struggling to pay your debts. 

Given the high sales and (relatively) low COGS, it looks like things are going well. 

3. Days of inventory outstanding (DIO)

This measures how long the average item remains unsold in your inventory and is a good way of estimating your ability to generate cash quickly. 

Because inventory is an asset but not cash, the faster you can sell items, the better. 

DIO can be applied to the entire inventory, or to specific products. Clearly, if certain items have a much longer DIO than the overall average, they’re proving harder to sell. Stocking fewer of these products in reserve can help you avoid tying up working capital.

You can work out your DIO using this formula:

DIO = (average inventory / COGS) x 365

For example:

You have £150,000 in stock at the beginning of the year and £100,000 left at the end. This makes your average inventory £125,000. Your COGS is still £5 million. 

Your DIO is: (125,000/5,000,000) x 365 = 9 days.

A DIO of nine days is another indicator that this business is very efficient with working capital. 

But the next metric will give you the full picture. 

4. Cash conversion cycle (CCC)

Your cash conversion cycle is the number of days it takes your company to convert money out into money coming back in. 

The goal is to have this number be as small as possible - even negative. In fact, a negative cash conversion cycle suggests serious growth.

Your CCC is arguably the most important working capital metric. Focus on getting this number down, and your business should soar.

To calculate your CCC, add your DSO (how quickly your customers pay) to your DIO (days in inventory), then subtract your DPO (how quickly you pay suppliers): 

CCC = DSO + DIO - DPO

For example:

Based on the calculations from the previous three metrics, you have:

• A DSO of 73 days

• A DPO of 91 days

• A DIO of 9 days

CCC: 73 + 9 - 91 = -9 days

In other words, money is coming in faster than it’s going out. Thanks to you supplier payment terms, you should be able to fund new growth.

5. Current ratio

Current ratio compares your current assets with your current liabilities. Sometimes known as your “working capital ratio,” it’s a very clear way to measure company liquidity. 

“Current” assets in this case means assets that are likely to be liquidated in the next year - that includes cash, receivables and inventory.

Current ratios are best considered by comparing them with the industry average. A low ratio suggests your business may be in financial distress or approaching default, while a high ratio indicates your business has good liquidity.

Your current ratio = current assets / current debts

For example:

If you have current assets worth £5 million, and current debts worth £4 million, your current ratio is 1.25. 

A ratio above 1 means you have the assets available to pay off your debts. For most small businesses, this is a healthy place to be. But you may be comfortable with a ratio below 1 where you’re borrowing to invest in programs or products that you’re confident will bring a strong return. 

6. Quick ratio

Like the current ratio, the quick ratio is a measure of liquidity that pits assets against liabilities. But in this formula, you only use your most liquid assets: cash, accounts receivable, cash equivalents and securities. These assets can be used to pay off debts quickly.

This notably excludes inventory, as those goods haven’t been sold yet. 

Again, your quick ratio will ideally be above 1. This means you’re ready to pay off debts whenever required. 

Quick ratio = “quick” assets / current liabilities

For example:

If your company has £4 million in cash, receivables and securities, and still has £4 million in debts. Your ratio is exactly 1. 

7. Accounts receivable turnover

This ratio represents the number of times in a stated period that your company collected its average AR balance. It’s a direct measure of how efficient your receivables process is.  

AR turnover = net credit sales / average accounts receivable

Note: Net credit sales excludes up-front cash payments - these aren’t receivables. Net sales also factors in discounts and other incentives. While these help get cash in more quickly, they also eat into profit. There’s a point where this becomes inefficient, which will be reflected in your ratio. 

For example: 

Your daily average sales are (£10,000,000/365 = £27,397. Let’s assume that all of these are receivables and no discounts were offered. 

You had £1.5 million in accounts receivable outstanding at the start of the year, and £1 million at the end. The daily average is therefore £3,425 (1,250,000/365).

AR turnover ratio is 27,397/3,425 = 8. This means you convert receivables to cash 8 times per year. 

Whether 8 is a high ratio again depends on your industry and past performance, but your overall goal should be to keep increasing that number.

Note: Whether you use daily figures (as above), monthly, or yearly, the turnover ratio should be the same.

8. Inventory to working capital ratio

This shows you the amount of total working capital dedicated to unsold stock. Generally speaking, a ratio of less than 1 implies that your business is highly liquid - that you turn inventory into cash efficiently.

The less working capital you have tied up in unsold inventory, the better.

Inventory to working capital = Inventory/working capital

For example:

Your balance sheet shows £800,000 spent on inventory (an asset). You have £200,000 in accounts receivable, thus your total assets are £1 million. 

If your liabilities are £500,000, your working capital would also be £500,000. 

Your inventory to working capital ratio is, therefore: 800,000/500,000 = 1.6

1 is where you ideally want this ratio to land. A ratio of 1.6 suggests that more working capital is tied up in inventory than is ideal over the long term. When the ratio is consistently above 2, you need to address your inventory turnover strategy. 

9. Working capital turnover

This metric shows how effectively you deploy working capital to generate sales and revenue. In other words, your money out leads directly to more money in. 

A higher working capital turnover ratio is generally better - this shows that investments are paying off. A low ratio might suggest that you’re holding too much in inventory, or that your sales motions are inefficient. 

Working capital turnover = net annual sales/average working capital

For example:

Again, let’s use £10 million in annual sales and £2,500,000 as your average working capital. 10,000,000/2,500,000 gives a working capital turnover ratio of 4:1. So for every dollar of working capital spent, you receive four in return. 

This shows a highly efficient use of working capital. 

Your turn to take working capital seriously

Most small businesses won’t have a close eye on every one of the metrics above - that’s probably overkill. However, the first four on this list are no-brainers, so we recommend calculating them regularly.

Cash conversion cycle and inventory turnover (DIO) are also seen as two of the most valuable growth drivers. The more you can optimise these and avoid tying up working capital, the better. 

Choose the metrics that make the most sense for your business and create processes to regularly track and measure them. Even better, choose dashboard tools that give you an instant look, so you don’t have to live inside spreadsheets 24/7.

To help get you started, we’ve created a handy working capital calculator. Simply download the editable sheet and populate it with your numbers to crunch out some of these key measurables.