Working capital ratio indicates the ratio of current assets to current liabilities; for example –
Current Assets $12,000 / Current Liabilities $6,000 = Working Capital Ratio 2.0
A low ratio indicates lack of working capital, a very high ratio might indicate that too much capital is tied up in stocks or lying idle in form of cash. A ratio of 2.0 is usually satisfactory.
No hard and fast rules can be laid down as to the amount of working capital which a firm requires, but it will be obvious that if current assets are insufficient to meet current liabilities, that is, there is no working capital, the firm will be unable to pay it’s debts as they arise and will be at the mercy of a creditor who might enforce it’s liquidation. A large surplus of total assets over total liabilities will not mean that the firm is stable, if there is a deficiency of working capital.
The working capital required, then, must be sufficient to enable a firm to conduct it’s normal trade without shortage of cash and to cover contingencies.