Working Capital and Liquidity Explained

What working capital is

Working capital is current assets minus current liabilities: the stock, work in progress, debtors and cash a business holds, minus what it must pay within a year. It is the financial slack that lets a company pay wages and suppliers while it waits to be paid itself.

Why profitable companies run out of cash

Profit is recognised when work is done or goods delivered; cash arrives later. A growing company must fund ever-larger debtors and work in progress out of its own resources. If growth outpaces the cash available to fund it, the company can be profitable on paper and unable to pay its bills — the overtrading pattern behind many construction failures.

Reading liquidity from a UK balance sheet

• Net current assets: positive means short-term assets cover short-term debts
• The trend matters: shrinking net current assets across periods signal tightening liquidity
• Cash versus debtors: a balance sheet heavy on debtors depends on customers paying on time
• Creditors due within one year: a large figure relative to cash is pressure

The current ratio

The current ratio — current assets divided by current liabilities — is the standard quick measure. Above 1 means short-term coverage; below 1 means the company relies on refinancing, asset sales or new income to meet its short-term obligations. Like all ratios it is a starting question, not an answer: composition matters as much as the total.

The limits of balance-sheet liquidity

A balance sheet is a snapshot of one day, filed months later. It cannot show you the bank balance today, agreed overdraft headroom or payment behaviour since. Use it to frame questions — how is this company funding its growth? — rather than to deliver verdicts.