To find the approximate amount of working capital a company should have, you should look at "working capital per dollar of sales." In other words, you are going to have to compare the amount of working capital on the balance sheet to the total sales, which is found on the income statement, not the balance sheet. A business that sells a lot of low-cost items, and cycles through its inventory rapidly (a grocery store) may only need 10-15% of working capital per dollar of sales. A manufacturer of heavy machinery and high-priced items with a slower inventory turn may require 20-25% working capital per dollar of sales. A company such as Coca Cola would probably fall somewhere between the two.
Calculating Working Capital Per Dollar of SalesHere's the formula for Working Capital per Dollar of Sales
Let's look at an example taken from an old annual report of Goodrich.
Sample Working Capital Per Dollar of Sales CalculationGoodrich provides systems for aircraft as well as manufacturers heavy-duty engines. Working Capital: $933,000,000 (current assets - current liabilities) Total Sales (found on the income statement) = $4,363,800,000
Let's plug the numbers into the formula:
Working Capital of $933,000,000 ÷ Total Sales of $4,363,800,000
The answer for Goodrich is .2138, or 21.38%. As a manufacturer of heavy duty machinery, GR falls within the 20-25% working capital per dollar of sales range. This is good and compares favorably to competitors.
This page is part of Investing Lesson 3 - Understanding the Balance Sheet. To go back to the beginning, see the Table of Contents. If you have already read this lesson, you can skip directly to the Balance Sheet Quiz.