The working capital over total assets ratio, sometimes referred to as the net working capital ratio, measures the net liquid assets of a business as a percentage of it’s total assets. The ratio is an indicator of the short term liquidity and financial strength of the business and indicates it’s ability to finance short term obligations.
Working Capital Over Total Assets Ratio Formula
The working capital over total assets ratio formula calculates the ratio by dividing the current assets less the current liabilities by the total assets of the business. It should be noted that the term working capital is broader than the usual working capital definition and, for the purposes of this ratio, refers to the difference between current assets (including cash) and current liabilities.
CA = Current assets (Assets that can be converted into cash within one year of the balance sheet date)
CL = Current liabilities (Liabilities due for payment within one year of the balance sheet date)
TA = Total assets
CA – CL = Working capital
Current assets, current liabilities, and total assets are found on the balance sheet of the business.
Working Capital Over Total Assets Ratio Example
The balance sheet below is used as an example to show how the working capital to total assets ratio is calculated.
|Long term assets||375,000|
|Total liabilities and equity||631,000|
The numbers used in the calculation of the working capital over total assets ratio are highlighted in the balance sheet shown above. In this example the current assets are 256,000, current liabilities are 195,000, and the total assets are 631,000.
Using the formula the working capital over total assets ratio is calculated as follows.
Working capital over total assets ratio = (CA - CL) / TA Working capital over total assets ratio = (256,000 - 195,000) / 631,000 = 9.7%
In this example the ratio shows that working capital represents 9.7% of the total assets.
Working Capital Over Total Assets Ratio by Industry
There is no correct value for the working capital over total assets ratio, generally a high ratio is a good thing. Its level will vary from industry to industry, and therefore it is important when making comparisons, to determine an industry ratio benchmark based on financial statements of a business similar to your own.
To illustrate the difference in the working capital to total assets ratio from industry to industry, the following table sets out the calculation of the ratio based on the Apple Inc. and Amazon balance sheets.
Apple: Working capital over total assets ratio = (CA - CL) / TA Working capital over total assets ratio = (73,286 - 43,658) / 207,000 = 14.3% Amazon: Working capital over total assets ratio = (CA - CL) / TA Working capital over total assets ratio = (24,625 - 22,980) / 40,159 = 4.1%
The working capital over total assets ratio of Apple (14.3%) is significantly higher than Amazon (4.1%) indicating the additional liquidity and financial strength the company has.
The results are summarized in the table below.
Understanding the Working Capital Over Total Assets Ratio Formula
Using the formula the following observations can be made.
- When current assets are equal to current liabilities, the working capital over total assets ratio is equal to 0.
- If the business has no long term assets or current liabilities, then the current assets are equal to the total assets and the working capital over total assets ratio is equal to 100%. The ratio can never be greater than 100%.
Generally a higher working capital over total assets ratio is indicative of liquidity and financial strength. However, care must be taken to investigate the reasons for a high ratio as increasing current assets might indicate inefficiencies in the management of inventory and accounts receivable (amount due from customers), or that the business has significant amounts of cash not being invested in the operations of the business.
Negative Working Capital to Assets Ratio
The working capital total assets ratio can be negative, indicating that current assets are greater than current liabilities. In general a negative ratio is viewed as a sign that the business is in financial distress and does not have the necessary liquid assets to pay its current liabilities as they fall due.
Care must be taken to investigate the reasons for a negative ratio as it can also indicate an efficient business which operates with low accounts receivable, using supplier credit to fund inventory. An example of this would be a supermarket retailer which is cash based and has a rapid turnover of inventory funded by its suppliers, the resulting negative net working capital will give a negative ratio that indicates operating efficiency rather than financial distress.
A continually declining working capital to assets ratio indicates that the current assets of the business are declining, a sign of a loss making business facing financial difficulties.
The ratio forms part of the Altman Z Score ratio where it is used as an indicator of financial distress. The lower the ratio the lower the Z score and the more financially distressed the business is considered to be.
Working Capital Over Total Assets Ratio and the Financial Projections Template
The working capital total assets ratio is not directly shown on the financial projections template, but the current assets, current liabilities and total assets are readily available on the balance sheet of the template, so it is a simply and worthwhile task to calculate the ratio using the formula above.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.