Calculate working capital interest using the formula: Interest = Principal × Rate × Time. First, determine your working capital amount (Current Assets - Current Liabilities). Multiply by the annual interest rate (APR), then multiply by the time fraction (days/365 or days/360). For example, $100,000 at 8% APR for 30 days using 365-day count: $100,000 × 0.08 × (30/365) = $657.53. Adjust for utilization percentage if you don't use the full amount constantly.

Working capital is Current Assets minus Current Liabilities. It represents the liquid resources available to fund day-to-day operations. Positive working capital means you can cover short-term obligations; negative means current liabilities exceed liquid assets. Working capital matters because it indicates financial health, operational efficiency, and whether you'll need external financing. Insufficient working capital can lead to cash crunches, missed payments, and business failure, while excess working capital may indicate inefficient asset use.

Simple interest calculates return only on the principal: I = P × r × t. Compound interest calculates return on principal plus accumulated interest: A = P(1 + r/n)^(nt). For working capital, most short-term facilities (under 90 days) use simple interest. Compound interest applies when interest isn't paid monthly and capitalizes (adds to principal). The difference grows over time—a $100,000 loan at 8% for 90 days costs $1,973 with simple interest but $2,013 with monthly compounding.

Opportunity cost is the return you forgo by tying capital in working capital instead of investing it elsewhere. For example, if you have $200,000 in slow-moving inventory that could instead earn 6% in treasury securities, your opportunity cost is $12,000/year. This concept helps evaluate whether to reduce inventory, extend payables, accelerate collections, or accept the trade-off. Calculate it using your best alternative investment return rate (hurdle rate, WACC, or market returns).

Working capital financing costs vary widely by creditworthiness, facility type, and market conditions. As of 2025: lines of credit range 6-12% APR for good credit, 12-20% for fair credit; invoice factoring costs 15-30% annualized; merchant cash advances can exceed 50% APR; overdraft facilities run 10-18%; asset-based lending charges 8-15% plus fees. SBA working capital loans offer 7-10% rates. Always calculate the effective APR including all fees, as stated rates understate true cost.

The working capital ratio (current ratio) is Current Assets ÷ Current Liabilities. A ratio of 1.2-2.0 is generally healthy—enough cushion to cover obligations but not excessive. Below 1.0 indicates potential liquidity problems. Above 3.0 may suggest inefficient asset use. However, "good" varies by industry: retailers operate with 1.0-1.5; manufacturers need 1.5-2.5; service businesses can thrive under 1.0. Compare to industry benchmarks and track trends over time rather than relying on a single number.

Reduce working capital costs by: (1) Improving cash conversion cycle—collect receivables faster, extend payables, reduce inventory; (2) Negotiating better loan terms—shop lenders, improve credit score, provide collateral; (3) Optimizing utilization—use only what you need, don't over-borrow; (4) Consolidating debt at lower rates; (5) Using invoice factoring strategically for high-margin sales; (6) Implementing just-in-time inventory; (7) Offering early payment discounts to customers; (8) Taking advantage of supplier payment terms instead of borrowing. Each 1% reduction in a $200,000 facility saves $2,000/year.

The 360-day method (banker's year) divides years into twelve 30-day months for easier calculation, common in commercial lending. The 365-day method (actual/365) uses calendar days, more common in consumer lending and investments. For the same APR and period, 360-day calculation results in slightly higher interest because you're using a smaller denominator. Example: $100,000 at 8% for 30 days is $666.67 (360-day) vs $657.53 (365-day)—a $9.14 difference. Always verify which convention your lender uses.

Yes, interest paid on business loans—including working capital financing—is generally tax-deductible as a business expense in most jurisdictions. This reduces the effective after-tax cost of borrowing. For example, if you pay 8% interest and your tax rate is 25%, your after-tax cost is 6% [8% × (1 - 0.25)]. However, tax laws vary by country and situation. Interest on loans used for non-business purposes may not be deductible. Consult a tax professional for your specific situation, especially for complex structures or international operations.

Negative working capital means current liabilities exceed current assets. This isn't always bad—companies like Amazon and Dell operate successfully with negative working capital by collecting customer payments before paying suppliers, effectively using supplier financing. However, it can indicate liquidity risk if you can't meet short-term obligations. Whether negative working capital is problematic depends on: business model (retailers often run negative), cash flow timing, access to credit, and industry norms. Monitor cash flow carefully and maintain credit facilities as a safety net.

Working capital and cash flow are related but different. Increasing working capital uses cash (investing in inventory/receivables); decreasing working capital generates cash (collecting receivables, reducing inventory). A growing company often experiences working capital drain—revenue growth requires more inventory and creates more receivables, consuming cash even while profitable. This is why profitable companies can run out of cash. Monitor both: positive working capital indicates solvency; positive cash flow indicates liquidity. Optimize the cash conversion cycle to minimize working capital needs while maintaining operational efficiency.

Working capital is best financed with short-term debt (lines of credit, overdrafts) that matches the temporary nature of the need. Debt is cheaper than equity and doesn't dilute ownership. However, consider: (1) Permanent working capital (baseline always needed) can be financed with term debt or equity; (2) Seasonal spikes should use revolving credit; (3) Rapid growth may require equity to avoid over-leveraging; (4) Startups without credit history may need equity initially. Use debt when cash flows are predictable and you can service interest; use equity when building long-term capacity or lacking creditworthiness.