How to interpret your business’s working capital ratio

Your working capital ratio is more than just a financial formula—it’s a key indicator of your business’s operational health. It's no surprise, then, that it is one of the first metrics lenders, investors, and even suppliers look at when assessing your reliability and financial stability.

In this article, we’ll break down what the working capital ratio is, how to calculate it, and—most importantly—how to interpret what it means for your business. Whether your ratio is low, high, or somewhere in between, understanding the story behind the numbers can help you make smarter decisions and avoid cash flow issues down the track.

What is the working capital ratio?

Before diving into the ratio itself, it's important to understand what working capital is. Essentially, your business's working capital is what’s left after you’ve tallied up your short-term assets and subtracted your short-term debts. It’s the money you have available to pay for immediate expenses, like wages or equipment repairs.

Your working capital ratio, on the other hand, is a measure of your business's liquidity—your ability to turn assets into cash and manage near-term financial responsibilities. It's commonly used by lenders and investors to gauge whether a business is well-positioned to meet its upcoming liabilities without running into cash flow problems.

How to calculate and interpret your working capital ratio

The working capital ratio formula is quite simple:

Working Capital Ratio = Current Assets ÷ Current Liabilities

So, if you have $150,000 in current assets and $100,000 in current liabilities, your working capital ratio would be:

$150,000 ÷ $100,000 = 1.5

This means your business has $1.50 in assets for every $1 of liabilities.

What your ratio means

Low (below 1): Liquidity warning

A ratio of less than 1 means your business has more short-term liabilities than assets—a red flag for potential liquidity issues. You may be struggling to cover costs like wages, suppliers, and rent, and lenders may see you as a high-risk borrower. If this is your current situation, it’s essential to take action quickly and explore ways to improve your cash flow—but more on that soon.

Healthy (between 1 and 2): Financial stability

A ratio between 1 and 2 indicates you're on solid financial ground. This is typically considered the ideal range, particularly for SMEs, as it shows you have a buffer to comfortably manage day-to-day operations and meet short-term obligations. It also positions you as a low-risk borrower in the eyes of lenders, which can help if you're applying for a loan.

Too high (above 2): Underutilised assets

When it comes to working capital ratio, higher isn't always better. In fact, a ratio above 2 points to potential inefficiencies with your assets and how they're being utilised. Whether you have excess cash or slow-moving inventory, your assets are sitting idle, instead of being reinvested into growth initiatives. In other words, you could be missing out on valuable opportunities to scale, innovate, or gain a competitive edge.

That said, in some industries with long cash cycles, like manufacturing or construction, a higher ratio may be intentional to maintain a safety buffer.

How to improve a negative working capital ratio

If your ratio is under 1, the first step is to pinpoint why. Look at your balance sheet and ask: are your accounts payable too high? Or your accounts receivable too low? Or perhaps you're carrying short-term debt that could be restructured?

Based on what you find, there are a few different strategies you can adopt:

• Speed up receivables by invoicing as soon as you can and offering early-payment incentives
• Consider invoice finance to free up cash tied in unpaid invoices
• Turn slow-moving stock into cash by selling it at a discounted price
• Apply for a short-term working capital loan as a way to generate more cash
• Build a cash reserve to dip into in the case of an emergency or unexpected expenses
• Refinance short-term debt into longer-term liabilities
• Work with suppliers to extend payment deadlines
• Cut or delay non-essential costs (like unnecessary subscriptions, office upgrades, or freelance costs for non-critical tasks)
• Increase your revenue by launching promotions or upselling to existing customers

If your working capital ratio is persistently low—or if it's affecting your ability to pay your employees or suppliers—it may be time to seek expert help. A broker, for example, can help review your finances, consolidate debt, and explore funding solutions tailored to your circumstances.

At Valiant, our expert brokers compare over 90 lenders to match you with the right finance solution and get your cash flow back on track. Get a quote today.

What to do if your working capital ratio is too high

A high working capital ratio may signal inefficient use of resources. You might be holding too much cash, inventory, or receivables when they could be better invested in growth. Here's what to do:

• Reinvest idle cash in growth initiatives, such as new product development, marketing, upgraded equipment, or expansion
• Move excess funds into a higher-yielding account or term deposit
• Analyse inventory levels and optimise your ordering process to reduce holding costs
• Negotiate supplier deals like bulk discounts or longer terms