Subtle changes in your profit and loss statement and balance sheet trends can tell you a lot about the health of your business. It’s always better to spot those changes early and resolve them before they become major cash flow, productivity, or profitability problems.
In this episode of the Financially Fit Business podcast, I cover one of my favorite financial trends: working capital.
Working capital is current assets minus current liabilities. It helps answer a very practical question: does the business have enough money to operate?
While the current ratio also gives insight into short-term financial strength, working capital can tell a slightly different story. For some companies, especially manufacturers or businesses that take large deposits for future work, working capital may increase even when profitability is moving in the wrong direction.
That’s why it’s important to understand what the trend is really showing.
Monthly Working Capital Can Move Up and Down
Monthly working capital can look like a seesaw. It may go up and down depending on cash coming in, bills being paid, payroll timing, COD work, seasonal activity, and other normal business cycles.
That movement isn’t always a problem.
The key is to watch whether working capital is moving toward zero or becoming negative. When that happens, even a profitable business can run into trouble. You may find yourself robbing Peter to pay Paul just to cover payroll, bills, and normal operating needs.
Trailing Working Capital Shows the Bigger Picture
The trailing working capital trend is often more useful because it smooths out some of the month-to-month movement.
Ideally, your trailing working capital should be stable or trending upward. Profitable sales and strong collections should eventually show up in this trend as the business builds cash strength.
Some owners use this trend to make major decisions. For example, they may wait until working capital reaches a certain level before buying another company, purchasing equipment, or investing in assets without taking on debt.
The important part is knowing your baseline. How low is too low? How much working capital do you need to keep the business financially healthy?
Set a Working Capital Baseline
I like owners to have enough cash to fund at least three months of payroll and three months of overhead expenses. That gives the business a stronger foundation when something unexpected happens.
You never know when you’ll need cash. A lawsuit, an owner event, a major purchase, or a seasonal downturn can quickly change the financial picture.
Working capital helps you see whether the business has enough strength to handle those situations.
Small Downward Changes Matter
Even small decreases in working capital should be investigated.
If working capital drops by 5%, ask why. Is the company less profitable? Did the business make a large purchase? Did the owner take money out? Was cash used to buy another company or asset?
These small changes matter because working capital gives a clear picture of the company’s financial health.
Working Capital Connects to Other Financial Ratios
Your financial ratios should generally support each other.
If net operating profit is going down, your current ratio, acid test, receivables-to-payables ratio, and working capital may also be going down.
If the ratios tell different stories, look deeper. There may be a reason, such as deposits for future work, a buildup of inventory, collection issues, or seasonal changes.
The goal is to understand what the trends are telling you before they become a crisis.
Listen to the Episode
In this episode, I explain why working capital is one of the most important trends to watch, how monthly and trailing working capital differ, and why subtle changes can reveal a lot about the financial health of your business.
Common Questions About Working Capital
What is working capital?
Working capital is current assets minus current liabilities. It shows whether a business has enough short-term financial strength to operate.
Why is working capital important?
Working capital helps show the financial health of a company. If it is trending down, the business may have cash flow, profitability, or collection issues.
Can working capital go up while profitability goes down?
Yes. This can happen when a business receives large deposits for future work. Those deposits may increase working capital before the revenue appears on the profit and loss statement.
What is a good working capital baseline?
A practical baseline is enough cash to cover at least three months of payroll and three months of overhead expenses.
Why should I watch small changes in working capital?
Small changes can signal bigger problems early. A slight decline may point to lower profitability, poor collections, large purchases, or cash being pulled from the business.