The Ratio Lenders Check First
When you apply for a business loan, line of credit, or even a vendor credit account, the first thing an underwriter looks at is your working capital ratio. Also called the current ratio, it is the simplest measure of whether a business can pay its short-term obligations. A ratio of 1.0 means you have exactly enough. Below 1.0, you technically cannot cover what you owe. Above 1.5, lenders consider you a lower risk.
The Small Business Administration emphasizes that maintaining adequate working capital is critical for business survival. SBA loan programs typically require borrowers to demonstrate a working capital ratio of at least 1.2 to qualify, and many conventional lenders set the bar at 1.5 or higher. Without sufficient working capital, you may find yourself locked out of the financing you need to grow.
What Working Capital Means for Daily Operations
Working capital is not an abstract accounting concept. It is the cash your business has available to operate on a day-to-day basis. It determines whether you can:
- Make payroll on time—the single most critical obligation. Missing payroll destroys employee trust instantly.
- Pay suppliers to keep inventory flowing—suppliers who do not get paid stop shipping. That stops your revenue.
- Take on new projects—growth requires upfront spending on materials, labor, and marketing before revenue comes in.
- Survive slow periods—seasonal dips, economic downturns, and losing a major client all drain working capital.
- Negotiate from strength—when you have cash, you can take supplier discounts (2/10 net 30 terms can save 36% annualized), buy materials in bulk, and avoid desperate pricing decisions.
Seasonal Businesses and Working Capital Swings
If your business has seasonal revenue patterns, your working capital ratio will fluctuate throughout the year. A landscaping company might have a ratio of 2.5 in August and 0.8 in February. A retailer might peak in December and bottom out in March. This does not necessarily mean the business is unhealthy—it means you need to plan for the cycle.
The Federal Reserve's consumer credit data shows that small business borrowing increases significantly during off-peak seasons as companies draw on credit lines to bridge working capital gaps. Seasonal businesses should calculate their working capital at the low point of their cycle, not the peak. If you cannot maintain a ratio above 1.0 at your worst month, you need a larger credit facility or more aggressive cash management.
Smart seasonal businesses build reserves during peak months specifically to fund off-season operations. A common rule of thumb is to set aside 15–20% of peak-season revenue into a dedicated operating reserve account.
How to Improve Your Working Capital
There are two sides to the equation, and improving either one helps:
Increase Current Assets
- Collect receivables faster. Send invoices immediately upon delivery. Offer a small discount (1–2%) for early payment. Follow up on overdue accounts within 48 hours, not 30 days. Consider invoice factoring for large outstanding amounts.
- Convert inventory to cash. Discount slow-moving stock. Reduce reorder quantities. Implement just-in-time ordering where feasible. Every dollar tied up in unsold inventory is a dollar not available to pay bills.
- Build cash reserves. Set a target of 3–6 months of operating expenses in cash. Automate transfers from your operating account to a reserve account every week.
Reduce Current Liabilities
- Negotiate longer payment terms. If you currently pay suppliers on net-15 terms, negotiate net-30 or net-45. This keeps cash in your account longer without costing anything.
- Pay down short-term debt. High-interest credit card balances and lines of credit drain working capital through interest charges. Prioritize paying these down or consolidating into longer-term loans with lower rates.
- Restructure debt. Convert short-term liabilities into long-term loans where possible. A 5-year term loan replaces a current liability with a non-current one, immediately improving your working capital ratio.
Working Capital vs. Cash Flow
Working capital and cash flow are related but different. Working capital is a snapshot—a balance sheet measure at a single point in time. Cash flow measures the movement of money in and out of your business over a period. You can have positive working capital and still have a cash flow problem if the timing of inflows and outflows does not match up.
For example, a construction company might have $200,000 in receivables (strong working capital), but those receivables are 90 days out while payroll is due Friday. The SCORE resource library offers free cash flow projection templates that can help you map out the timing of your inflows and outflows alongside your working capital position.
Warning Signs to Watch
Monitor these indicators that your working capital is deteriorating before a crisis hits:
- Ratio trending downward over three or more consecutive months, even if it is still above 1.0.
- Growing accounts payable faster than accounts receivable. This means you are falling further behind with suppliers.
- Increasing reliance on credit lines to cover routine operating expenses, not just one-time purchases.
- Delaying vendor payments beyond agreed terms to manage cash. This damages supplier relationships and can lead to losing favorable terms.
- Inventory buildup without corresponding revenue growth. Excess inventory ties up cash and may indicate weakening demand.
Sources
- U.S. Small Business Administration — Manage Your Finances — Financial management guidance for small businesses
- Federal Reserve — Consumer Credit Report (G.19) — Data on lending and credit trends
- SCORE — Templates & Resources — Free financial templates including cash flow and working capital worksheets