The working capital ratio is a financial metric that compares a company’s current assets to its current liabilities. It is calculated by dividing current assets by current liabilities. A ratio greater than 1 indicates that a business has enough assets to cover its short-term obligations, while a ratio less than 1 means that the business may struggle to meet its immediate financial commitments.
For ecommerce businesses, the working capital ratio is an important indicator of financial health. A strong working capital ratio ensures the business can pay its suppliers and employees, as well as fund day-to-day operations. Conversely, if the ratio is too low, it may signal cash flow issues, which could impact the business’s ability to grow or meet demand. Ecommerce businesses should strive to maintain a healthy working capital ratio by managing inventory efficiently and optimizing payment terms with vendors.
In certain cases, if the company has a really positive (and low) cash conversion cycle, this can lead to a low working capital ratio, as this means the Accounts Payable (AP) may be much more significant than the Accounts receivable (AR) and inventory.