What is working capital?
Working capital is the money a business uses to operate day to day. It is calculated as:
Working capital = current assets − current liabilities
- Current assets are things that will turn into cash within 12 months: cash, debtors (accounts receivable), stock and prepayments.
- Current liabilities are obligations due within 12 months: creditors, GST and PAYE owing, provisional tax, overdrafts and the current portion of loans.
The working capital ratio
Working capital ratio (current ratio) = current assets ÷ current liabilities
| Ratio | What it suggests |
|---|---|
| Below 1.0 | Current liabilities exceed current assets; short-term pressure likely |
| 1.0 to 1.2 | Tight; little buffer for surprises |
| 1.2 to 2.0 | Generally comfortable for many SMEs |
| Above 2.0 | Strong, but check for idle cash or excess stock |
These bands are rough guides only. Industry matters. A supermarket turns stock quickly and is paid in cash, so it can operate with a lower ratio. An engineering firm with long projects and slow-paying customers needs a higher one.
The quick ratio
Stock is not always easy to turn into cash. The quick ratio, or acid test, excludes it:
Quick ratio = (current assets − stock) ÷ current liabilities
If your current ratio looks healthy but your quick ratio is well below 1, the business depends on selling stock to meet its obligations. That is a risk if sales slow.
The cash conversion cycle
Ratios are snapshots. The cash conversion cycle (CCC) shows how long cash is tied up in the trading cycle:
CCC = debtor days + stock days − creditor days
- Debtor days: how long customers take to pay.
- Stock days: how long stock sits before it sells.
- Creditor days: how long you take to pay suppliers.
A CCC of 50 days means the business funds 50 days of trading from its own cash or borrowing. You can estimate the cash involved with the calculator on our working capital finance page.
A worked example
Illustrative figures only. A Christchurch wholesaler has:
| Item | Amount |
|---|---|
| Cash | $40,000 |
| Debtors | $380,000 |
| Stock | $260,000 |
| Current assets | $680,000 |
| Creditors | $210,000 |
| GST and PAYE owing | $55,000 |
| Overdraft | $120,000 |
| Current portion of loans | $60,000 |
| Current liabilities | $445,000 |
- Working capital = $680,000 − $445,000 = $235,000
- Current ratio = 680 ÷ 445 = 1.53
- Quick ratio = (680 − 260) ÷ 445 = 0.94
The current ratio looks comfortable, but the quick ratio is below 1. The business relies on selling stock to meet its obligations. If a large customer paid late, pressure would build quickly.
Why does growth weaken working capital?
When sales rise, debtors and stock usually rise first. Cash goes out to pay for stock and wages before it comes back from customers. A profitable business growing quickly can see its working capital ratio fall and its overdraft rise at the same time. This is one of the most common reasons established SMEs seek working capital finance.
How to improve working capital
Speed up debtors
- Invoice immediately on completion or delivery.
- Shorten payment terms for new customers.
- Chase overdue accounts on a fixed schedule.
- Offer convenient payment methods.
Xero data for the June 2026 quarter showed New Zealand small businesses waiting an average of 24.1 days to be paid, with payments arriving 4.7 days late on average. Our debtor management guide covers practical steps.
Reduce stock
- Review slow-moving items and clear them.
- Order more frequently in smaller quantities where freight costs allow.
- Negotiate consignment arrangements for some lines.
Manage creditors sensibly
- Use the full terms your suppliers offer, without paying late.
- Negotiate longer terms with key suppliers when volumes grow.
- Weigh early-payment discounts against the cash cost.
Restructure short-term debt If current liabilities include short-term loans that could be refinanced over a longer period, consolidation can improve both the ratio and actual cash flow.
Watch the trend, not just the number
A single ratio tells you little. Track it monthly alongside a 13-week cash flow forecast. A steadily falling ratio is an early warning worth acting on, well before it becomes a problem with suppliers, staff or Inland Revenue.
Quick answers
What is a good working capital ratio?
It varies by industry. A ratio comfortably above 1 is generally healthy for an SME, but a business with fast-moving stock and cash customers can run lower, while a business with slow stock needs more.
Can a working capital ratio be too high?
Yes. A very high ratio can mean cash is sitting idle or too much is tied up in stock and debtors. It is worth checking whether the capital could be used better.
Does GST owed count as a current liability?
Yes. GST collected but not yet paid to Inland Revenue is a current liability, as are PAYE and provisional tax due within 12 months.
How does working capital finance affect the ratio?
A facility repayable within 12 months is a current liability, so it may not improve the ratio on paper. A longer-dated facility can. More importantly, it improves actual cash available to run the business.