Working capital management: Optimize your business liquidity

Published 10 March 2026

Table of contents

• What is working capital management?
• How to calculate working capital
• Ratios that show your working capital health
• Tips for improving working capital management
• How software supports working capital management
• Improve working capital management with Xero
• FAQs on working capital management

Key takeaways

• To optimise your working capital, balance your cash, receivables, payables, and inventory so you can cover bills on time and fund growth without stress.
• Focus on a few simple checks: net working capital, current and quick ratios, and your cash conversion cycle.
• Speed up cash in, use supplier terms strategically, and right-size your stock so you avoid wrapping up cash in unsold inventory and boost your working capital.

What is working capital management?

Working capital management is how you manage money for your business's expenses. To optimise your working capital, you need to:

• have enough cash on hand to cover bills, payroll, and debt repayments
• avoid stockpiling excess cash that could be used somewhere else in the business

The British Business Bank has more on the importance of working capital.

How to calculate working capital

To calculate working capital, pull up a balance sheet, find your current assets and liabilities, and then do the following calculation:

Working capital = current assets – current liabilities

• Current assets include cash in bank accounts, inventory, and any other assets that are likely to be converted to cash within the year.
• Current liabilities include all bills and debt repayments due within the year.

You may also want to calculate the working capital ratio:

Working capital ratio = current assets ÷ current liabilities

Anything above 1 indicates you have enough money coming in to cover your short-term liabilities, while anything under 1 indicates a potential shortfall.

If you're short, you may need to borrow money. There are loans specifically designed to boost working capital – check out the British Business Bank's resource on working capital financing or look at the government's working capital scheme for exporters.

Ratios that show your working capital health

Although your working capital shows you whether you have enough funds to cover your expenses, it's not the whole story. The following ratios can help you judge the health of your working capital and identify when you need to improve operations.

Quick ratio

The quick ratio shows you whether you can cover bills without selling any inventory.

Quick ratio = (current assets – inventory) ÷ current liabilities

Again, any result over 1 means you have enough working capital to cover your bills, while anything under 1 indicates you may be short on funds. The quick ratio addresses a limitation of the working capital ratio – while the working capital ratio assumes you'll sell your inventory, the quick ratio takes inventory out of the equation.

Cash ratio

The working capital ratio also assumes you'll use all your current assets to cover your short-term liabilities. The cash ratio is a stricter measure, showing whether you could pay your bills using only cash and cash equivalents:

Cash ratio = (cash + cash equivalents) ÷ current liabilities

If you're at 1 or higher, you have enough cash to cover expenses. But if you're under 1, you’ll struggle.

Cash conversion cycle

The cash conversion cycle shows how long it takes your business to:

• pay its bills
• turn inventory and other short-term assets into cash

To calculate the CCC, you need to know your:

• days payable outstanding (DPO): how long the business takes to pay its bills (the number of creditor days)
• days inventory outstanding (DIO): how long it takes to sell inventory
• days sales outstanding (DSO): how long it takes to collect outstanding invoices (accounts receivable) – also called debtor days.

Plug those numbers into this formula:

CCC = DIO + DSO – DPO

For example, if it takes 10 days to sell inventory, 12 days to collect invoices, and 5 days to pay your bills, your cash conversion cycle is 17 days.

Tips for improving working capital management

Here are some ways to manage your working capital as efficiently as possible:

Reduce debtor days

Keeping debtor days down helps you get the working capital you need to stay on top of your expenses, and also reduces your risk of default. The longer customers take to pay, the greater the chance they won’t pay at all.

To reduce your debtor days, send invoices promptly, follow up with reminders, and have a clear late-payment policy. Consider offering early payment discounts – but only if you think they'll speed up payment without cutting into your cash flow.

Pay your bills on time – not early

Increasing creditor days (days sales outstanding) means taking longer to pay your bills so you keep more working capital on hand to cover other expenses. But do so responsibly so you don't incur late fees, damage relationships with vendors, or risk losing services.

Right-size your inventory

You need just enough inventory on hand to meet customers needs without wrapping up excess cash in inventory that doesn't sell. To improve your inventory management efficiency, track how inventory sells. Stock items that sell quickly, and if you diversify your inventory, buy the types of items that sell the fastest. If some items aren't selling, consider marking down their prices to bring in cash and cut your losses.

Map order to cash and procure to pay

Track how quickly money comes in and out of the business by mapping:

• order to cash: the time from when you accept an order from a customer until they pay the invoice
• procure to pay: the time between when you make an order and you pay the bill

Although both have a direct effect on your working capital, you're dealing with accounts receivable vs accounts payable so you need to manage them differently. To boost cash on hand, you want a quick order to cash (better known as accounts receivable) process and a longer procure to pay (also called accounts payable) timeline.

To improve working capital management, check out the British Business Bank's resource on dealing with working capital problems.

How software supports working capital management

The right accounting software can help you improve working capital management by:

• automating invoicing and collections: Send invoices electronically, automate reminders, and offer customers convenient digital payment options.
• streamlining payables and approvals: Automate the accounts payable process to make sure you pay bills on time (and not too early).
• tracking inventory and COGS in real time: Use real-time inventory management tools so you always know how much inventory you have on hand, what's selling, and which products bring in the most profit. Then, use those insights to improve your inventory management.
• forecasting cash and setting alerts: Use cash flow forecasting tools to see if (and when) you'll have cash to pay bills. Set alerts to notify you when cash is running low.
• integrating payments and apps: Integrate apps that make it easier for customers to pay you quickly and conveniently.

Improve working capital management with Xero

Xero gives you the data you need, when you need it, to help you manage your working capital. With Xero, it's easy to pull balance sheets, check working capital ratios, and generate cash flow reports so you always know how much cash you have and how much to pay out – and when cash flows in and out of the business so you can plan ahead.

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FAQs on working capital management

Learn more about working capital management with these FAQs:

What is a good working capital ratio?

A good working capital ratio is 1.2 to 2. A ‘1’ means your short-term assets are exactly equal to your short-term liabilities, so 1.2 gives you a buffer in case customers pay invoices late or inventory sales drop.

Anything above 2 indicates that you have too much unused cash lying around, and you should find ways to invest those funds into your business.

What is the difference between working capital and cash flow?

Working capital shows you whether you have enough assets to cover your short-term liabilities (like expenses, payroll, and loan repayments) for the coming year. Cash flow shows how cash moves in and out of your business. You must pay attention to both to manage your finances and cash flow.

How often should I calculate working capital?

You should calculate working capital at least quarterly, but potentially monthly or weekly, depending on your business's finances. You'll then be able to see whether you have enough money to pay your bills or whether you're hoarding cash that could be used to grow the business.

What if my working capital is negative?

Negative working capital means you don't have enough current assets to cover your current liabilities. To survive, you need more cash. You could:

• work how to increase sales or get customers to pay outstanding invoices, or identify which bills you can put off and where to reduce expenses.
• take out a working capital loan – but if you do, have a plan to repay it or you'll end up deeper in the hole

What is a realistic target for debtor days in the UK?

Anything under 45 days is a realistic target. Ideally, you want to be within the 30–45 day range. Debtor days are the number of days customers take to pay outstanding invoices – they’re also called days sales outstanding or DSO.

Do seasonal businesses need more working capital?

Not necessarily. But seasonal businesses may need to pay closer attention to their working capital management than businesses with a steady revenue stream. Seasonal drops in revenue can make it harder to stay on top of bills – especially bills that aren't tied to revenue, such as rent, utilities, and admin costs.