How the calculator works
- Current assets = cash + money customers owe you + stock + other current assets.
- Current liabilities = money you owe suppliers + tax owed + everything else due within 12 months.
- Working capital = current assets − current liabilities.
- Current ratio (also called the working capital ratio) = current assets ÷ current liabilities.
- Quick ratio = (cash + money customers owe you) ÷ current liabilities. It leaves out stock and prepayments, which cannot pay a bill next week.
A worked example
An electrical contractor's Balance Sheet at the end of the month. Made-up figures to show the arithmetic.
| $ | |
|---|---|
| Bank | 42,000 |
| Accounts Receivable | 68,000 |
| Stock (cable, fittings, switchboards) | 25,000 |
| Prepayments (insurance paid for the year) | 5,000 |
| Current assets | 140,000 |
| Accounts Payable | 38,000 |
| GST, PAYG and super owed | 22,000 |
| Credit card, wages owed and van loan repayments due this year | 40,000 |
| Current liabilities | 100,000 |
- Working capital: $140,000 − $100,000 = $40,000.
- Current ratio: $140,000 ÷ $100,000 = 1.40. Inside the usual 1.2 to 2 range.
- Quick ratio: ($42,000 + $68,000) ÷ $100,000 = 1.10. Still above 1 without the stock.
The ratios look fine, but the detail matters. Cash alone is $42,000 against $100,000 due, so paying its way depends on collecting the $68,000 customers owe. And $22,000 of the bank balance is tax that belongs to the tax office. If $15,000 of what customers owe turned out to be uncollectable, the quick ratio would fall to ($42,000 + $53,000) ÷ $100,000 = 0.95. Press "Load the worked example" above to see it in the calculator.
Builders and trades contractors usually need the most working capital at the start of a big job: wages and materials go out weeks before the first payment arrives, and retention holds back part of every invoice. The construction cash flow projection guide works through one contract month by month and shows how far the bank dips.
The same applies to any new customer on credit terms: a customer paying 30 days after each invoice ties up about a month of what they buy until the work ends. The incremental cash flow guide counts that money, with the equipment and the extra costs, to decide whether a contract is worth taking.
Getting the figures from Xero
- Go to Accounting › Reports › Balance Sheet and pick the last day of last month.
- Cash: the total of the Bank section at the top. Xero shows it apart from Current Assets, but it is a current asset.
- Current assets: Accounts Receivable, the inventory line and anything else under Current Assets (prepayments, deposits).
- Current liabilities: Accounts Payable, GST or VAT, PAYG or PAYE, wages and super or pension owed, credit cards, and any loan repayments due within the year. How to read a balance sheet in Xero explains each section.
- To check the ratio, Xero's Executive Summary report shows "current assets to liabilities" by month. The Executive Summary explained covers the other ratios on it.
How to improve working capital
- Collect faster. Money owed by customers is usually the biggest current asset that is not cash. Invoice the day the work is done and chase the oldest balances first. The debtor days calculator shows how late customers pay against your terms.
- Hold less stock. Stock counts in the current ratio but cannot pay a bill. How to calculate stock days shows how much is sitting idle.
- Pay suppliers on the due date, not before. How to calculate creditor days shows whether you pay early.
- Move short-term debt to a longer term. Equipment bought on a credit card or overdraft weighs on the ratio; a term loan spreads it out.
The cash conversion cycle calculator shows how long your cash is tied up in customers and stock, and how to improve cash flow ranks the levers. If the ratio is fine but the bank is still tight, see profit but no cash.
Questions
- What is working capital?
- Working capital is current assets minus current liabilities: the cash and things that should turn into cash within a year, less everything you have to pay within a year. It is the cushion the business runs on between paying its bills and being paid.
- What is the working capital ratio?
- It is current assets divided by current liabilities, also called the current ratio. A ratio of 1.40 means every $1 due within the year is covered by $1.40 of cash, money owed to you, stock and other current assets. Xero's Executive Summary report shows the same ratio as "current assets to liabilities".
- What is a good current ratio for a small business?
- Between about 1.2 and 2 is the usual comfortable range. Below 1 means the business owes more in the next year than it has in current assets. Above 2 is safe, but can mean cash sitting idle or money stuck in unpaid invoices and stock. The trend matters more than one reading: compare it with last quarter and last year.
- What is the difference between the current ratio and the quick ratio?
- The quick ratio leaves out stock and prepayments, because they cannot pay a bill next week. It is cash plus money customers owe you, divided by current liabilities. A business with a current ratio of 1.5 and a quick ratio of 0.6 only pays its way if its stock sells in time.
- Does the bank count as a current asset in Xero?
- Yes. Xero lists bank accounts in their own Bank section above Current Assets, but cash is a current asset, so add it in. If an account is overdrawn, enter it as a negative number or include the overdraft in the amounts due within 12 months.
- Where do loans and director loans go?
- Only the part of a loan due within the next 12 months is a current liability; the rest is non-current. Xero puts a loan wherever its account is set up, so check with your accountant. A director or shareholder loan sitting in current liabilities can make the ratio look weak when the director has no plan to take the money out; it is worth knowing which part is really due.
- Are my figures stored or sent anywhere?
- No. The calculation runs in your browser. Nothing you type is saved or sent to our server or anyone else. The only exception is if you ask us to email you the result: then your email address and a short summary of the result are stored, and nothing is sent until you confirm.
No Xero needed
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We email a link to confirm first; nothing else is sent until you press it. Then the sample, a few related emails over three weeks and a monthly cash check. One click to unsubscribe.
This calculator gives an estimate from the figures you enter. It is not financial advice. Xero is a trademark of Xero Limited. This tool and ReportPilot are independent and are not made or endorsed by Xero.