BDC Explains Working Capital Formula and Importance

The Business Development Bank of Canada (BDC) has published an in-depth guide clarifying the concept of working capital. Defined as a company's current assets minus its current liabilities, working capital is presented as essential for daily operations and business growth.

BDC emphasizes that profitability alone does not guarantee financial stability. "A healthy balance sheet will mean that you’re going to have a healthy company," states Nicolas Fontaine, Senior Business Advisor at BDC Advisory Services. He cautions that neglecting working capital management can hinder a company's ability to expand and lead to financial difficulties.

The formula for calculating working capital is straightforward: Working capital = Current Assets — Current Liabilities. Using the example of ABC Co., with $120,000 in current assets and $70,000 in current liabilities, the working capital is $50,000.

The guide also introduces the working capital ratio (current ratio), which indicates the amount of working capital available for every dollar of current liabilities. Fontaine suggests an ideal ratio is between 1.5 and 2. However, he advises caution if the ratio is largely composed of slow-moving inventory. BDC urges businesses to actively monitor their working capital to ensure sufficient liquidity and fund growth.