Working capital riddle: why the ups and downs, when overall financials are healthy?

We were recently asked a great question by a client – why, in some months, does the working capital ratio improve, while the current ratio declines? Both are measures of balance sheet health, so why aren’t they moving in the same direction? Let’s look at an example.

In the graph pictured, December was a strong surplus month. This had a positive impact on the working capital in weeks, moving that ratio up. All other things being equal, the current ratio (current assets / current liabilities) should also move positively, however…

Significant grants in advance were received in December. For this client, grants received are treated as liabilities until the funded activity is delivered (when it then becomes income). Large liabilities (even if it is the best kind of liability – funding in advance), drag down the current ratio. The impact of a surplus month on the current ratio was overrun by the increase in liabilities.

The takeaway here is that financial health ratios should all move positively, with good financial performance over time (six months should give a good read). Certain ratios though, due to their design, can be impacted in a particular month and their relevance weakened, even where they are technically correct.
2024-01-17T04:07:00+00:00 September 14th, 2023|NFP sector|