Understanding Net Working Capital and How to Calculate It

Net working capital (NWC) measures a company’s liquidity, operational efficiency, and current financial health. If the company has considerable positive working capital, then it has the prospective to invest and grow. If a company’s current assets exceed its current liabilities, it will not face any difficulty growing or paying its creditors back. However, if it does not, the company may have difficulty growing and can even go bankrupt.

Ideally, a business should have a positive net working capital and keep the working capital ratio somewhere between 1.2 and 2.0. This portrays a healthy business that has sufficient short-term or current assets to secure its immediate debt completely. Therefore, working capital management is of utmost importance for all companies. It is the key to the company’s growth and its future in the market.

What is net working capital?

Working capital or net working capital is the monetary sum of current assets of a company, such as available cash, receivable accounts (clients’ unpaid bills), and inventories of finished goods and raw materials subtracted from its current/present liabilities, such as the accounts payable. 

Net operating working capital is the degree of a company’s liquidity and denotes the difference between current assets in operation and current liabilities in operation. In several cases, these calculations are the same and are compiled from the company cash added to accounts receivable and inventories, from which the accounts payable and future expenses are subtracted.

Formula for Working Capital

The standard formula for NWC is current assets minus current liabilities.

Working capital management 

There are several ways to improve your net working capital. Some of them are selling long-term assets for funds, refinancing short-term debts with long-term debts, increasing inventory turnover, etc. These can help improve a business’s short-term liquidity.

These are some ways to manage working capital for your business:

  1. Sell long-term business assets for cash – Long-term assets like equipment and pieces of machinery are not considered current assets. If a company has barely used long-term assets such as old office equipment, business-owners can consider selling them for cash. This increases the company’s working capital since cash is a current asset, whereas equipment is a long-term asset and is not included in the net working capital formula.
  2. Refinance short-term debt with long-term debt – Short-term debts are a company’s current liabilities due within one year or less. After refinancing short-term debt with long-term debt, it is not to be included in the calculation of the NWC any longer, aside from the total portion of principal due in one year. Long tenor business loans helps with ensuring a reduction in immediate liabilities. This helps increase a company’s NWC by lowering current liabilities.
  3. Increase inventory turnover – Business owners may take time to review their inventory and develop ways to increase their inventory turnover so as not to become overstocked. Although inventory is a current asset, it is not as liquid as cash. One may sell their inventory for a premium. For example, if a company’s inventory is worth Rs.1000, but they can sell it for Rs.1500 in cash, their current assets will increase by Rs.500.

What does positive, zero, and negative net working capital mean?

  • Positive net working capital – This indicates a company can meet its present financial requirements and has funds to spare for expansion, investment, operational development or innovation, emergencies, etc.
  • Zero net working capital – This indicates a company’s liquidity is adequate to meet all its financial responsibilities but does not have the surplus cash flow for investment, expansion, etc.
  • Negative net working capital – This indicates a company cannot repay its present debt and will need to know how to use working capital loans or new investment to continue its operations and thereby preserve solvency.

Being clear on these concepts is key to proper working capital management. 

To aid in a business’ net working capital, top NBFCs and financial institutions provide pre-approved offers, making financing simpler and more time-efficient. The offers are available on various financial products such as personal loans, business loans, etc.

The financial model for predicting net working capital is driven commonly by a set of processes within the company’s financial workflows with respect to current assets and current liabilities. The above-mentioned points can help most companies with their working capital management. Net working capital represents a company’s liquidity, operational efficiency, and current financial health. To calculate the working capital, one needs to subtract the current liabilities from the current assets.

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