Working capital is one of those concepts that often sounds more complicated than it really is. But believe us, understanding it properly can make the difference between your business breathing easy or constantly gasping for air. Why? Because it’s directly tied to liquidity, the ability to operate smoothly, and ultimately, the real financial health of your daily operations. And when it comes to buying or selling a company, this is absolutely crucial.

Simple definition of working capital

Let’s get straight to the point: working capital is the difference between a company’s current assets and current liabilities. Put even more simply, it’s what you’ve got left after paying off all your short-term debts using your short-term resources.

If you think about it, it’s like checking your bank account after paying all your monthly bills: do you still have something left to keep going? That’s it.

What is working capital used for in a business?

It’s used for something as basic as keeping the company running. That money pays salaries, restocks inventory, covers supplier payments and helps you survive when, say, an important client delays payment.

Healthy working capital means breathing room. Low or negative working capital leads to tension, financial stress... and rushed decisions. So, if you're considering buying a business, this figure should be high on your radar.

How to calculate working capital step by step

The formula for working capital

The basic formula is:

Working Capital = Current Assets – Current Liabilities

And by “current”, we mean anything that comes in or goes out within the next 12 months. Things like cash, accounts receivable, inventory… versus short-term debts, loans or pending payments.

Real-life example with actual numbers

Imagine a company with:

• €150,000 in accounts receivable

• €50,000 in inventory

• €30,000 in cash

• And €120,000 in short-term liabilities

So:

Working Capital = (150,000 + 50,000 + 30,000) - 120,000 = €110,000

That means it has €110,000 available to operate. Not bad, right?

Difference between positive and negative working capital

What does it mean to have negative working capital?

Negative working capital means you can’t cover your short-term obligations with your most liquid assets. In other words: you’re short on cash. This can lead to missed payments, tension with suppliers, or even the need to borrow more money to get by. And of course, that triggers a snowball effect.

Situations where it’s crucial to keep it under control

Sometimes, low working capital isn’t necessarily a bad thing. For example, in fast-moving businesses (like certain e-commerce stores or food franchises), having little circulating capital may actually signal efficiency. But in most cases (especially if margins are tight) it’s better to have a buffer.

Factors that affect changes in working capital

There are plenty of reasons why your working capital might go up or down. Here are some of the most important ones:

• Delays in collecting invoices

• Increased idle inventory

• New loans or urgent payments

• Changes in payment policies with suppliers

• Rapid growth (yes, growing too fast can also cause stress)

Ultimately, any imbalance between what comes in and what goes out in the short term will impact your working capital.

Working capital vs cash flow: are they the same?

Good question, because people mix them up all the time.

Working capital is a snapshot, a fixed point in time. Whereas cash flow is a continuous film, tracking what goes in and out of the business over a specific period.

You could have great working capital and terrible cash flow… or the other way around. That’s why you should never rely on just one financial metric. Look at the whole picture.

How to optimise working capital management

Good practices to improve operational liquidity

Here are some tips we usually recommend:

• Negotiate better payment terms with suppliers, without harming the relationship.

• Reduce idle inventory, even if it’s tempting to stockpile.

• Collect payments earlier, if possible. Obvious, yes, but many businesses don’t chase up invoices enough.

• Automate processes to save time and resources.

• Use credit lines as occasional support, not a regular habit.

Key financial indicators to track it

Besides working capital itself, you might want to monitor:

• Current ratio = Current Assets / Current Liabilities

• Cash conversion cycle = Number of days from paying to getting paid

These indicators help you understand whether you’re managing circulating resources effectively or if something needs tweaking.

Common mistakes when analysing working capital

• Thinking “more is always better” (sometimes, too much idle capital is inefficient).

• Ignoring the business’s seasonality.

• Using formulas without adapting them to the industry.

• Confusing working capital with profitability (they’re not the same).

• Forgetting that behind the numbers are people, processes, and real operational decisions.

And if you’re buying a company, don’t blindly trust what the seller tells you. Always review the balance sheets, check the breakdown of receivables and make sure the inventory reflects the real value of what’s there, not just what’s on paper.

Conclusion: the importance of maintaining a balanced working capital

We could sum it up like this: working capital isn’t just a nice number in a spreadsheet. It’s a sign of how the company breathes, whether it can keep going or is about to run out of fuel halfway down the road.

If you’re thinking of selling your business or buying one that’s already up and running, analyse this indicator carefully. And if you need help with that process, Business in Spain is here to support you. We’ve been advising business sales for years and we know that success often doesn’t lie in the big numbers… but in the little details others overlook.