Net working capital (NWC) is used to determine the financial health of a business by calculating the difference between a company’s current assets and current liabilities. You can use NWC to evaluate a company’s financial trends, growth projections, and solvency. You can use our calculator below to determine your company’s NWC.
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Net Working Capital Calculator
Net Working Capital Formula
Net working capital = Current assets – Current liabilities
Current Assets
Current assets (also known as liquid assets) are items on your balance sheet that can be converted to cash within a year or less. This includes cash, marketable securities, accounts receivable (A/R), inventory, and cash equivalents, such as:
- Treasury bills
- Short-term government bonds
- Commercial paper
- Money market funds
Current Liabilities
Current liabilities are short-term financial obligations due within one year. Current liabilities usually include:
- Short-term loans
- Lines of credit
- Accounts payable (A/P)
- Accrued liabilities
- Other debts, such as credit cards, trade debts, and vendor notes
The sum of monthly payments of long-term debt―like commercial real estate loans and small business loans―that will be made within the next year are also considered current liabilities.
Net Working Capital Example
Let’s say your company has the following current assets:
Current Assets | Asset Value |
|---|---|
Cash & cash equivalents | $50,000 |
Accounts receivable (A/R) | $5,000 |
Inventory | $10,000 |
Total current assets: | $65,000 |
Plus, your company has the following current liabilities:
Current Liabilities | Asset Value |
|---|---|
Short term loans | $20,000 |
Accounts payable (A/P) | $7,000 |
Accrued liabilities | $4,000 |
Total current liabilities | $31,000 |
In this example, we’ve added the total current assets of your business in one table, and added the total current liabilities in another. Once we’ve determined both values, we can subtract the liabilities from the assets to determine NWC.
$65,000 (current assets) – $31,000 (current liabilities) = $34,000 (NWC)
Why Is Net Working Capital Important?
NWC is an important indicator of a company’s financial performance and solvency. It demonstrates the number of short-term business assets that are available for a business to pay its short-term obligations.
Positive NWC shows that a company has the financial resources to pay its current obligations with its short-term liquidity. In doing so, it can promote future growth and allow for borrowing power should you apply for financing. That being said, while a business should have a positive NWC, an NWC that’s too high signifies a business that may not be investing its short-term assets efficiently. On the other hand, a negative NWC means that a company will typically need to borrow or raise money to remain solvent.
Changes in Net Working Capital
Changes in NWC can demonstrate the financial trends of a business over time. NWC fluctuations can show you if your short-term business assets are increasing or decreasing in relation to your short-term liabilities. An increase or decrease in NWC is useful for monitoring trends in liquidity from year-to-year or quarter-to-quarter over a period of time.
It’s worth noting that if you make a major financial decision, such as taking out a loan or a lease for equipment, your NWC will be impacted in the near term. You can get a clearer picture of the financial trends of your business over time by assessing changes in NWC, which can be useful when making business decisions.
To measure the change, you can use the following formula:
Change In Net Working Capital = Current Net Working Capital – Previous Net Working Capital
Net Working Capital Ratio
The NWC ratio, also known as the current ratio, measures the percentage of a company’s current assets to its short-term liabilities. Similar to NWC, the NWC ratio can be used to determine whether you have enough current assets to cover your current liabilities.
The NWC ratio can be calculated as follows:
Current Assets | |
Net Working Capital Ratio = | Current Liabilities |
The optimal NWC ratio is between 1.5 to 2.0. Anything higher could indicate that a company isn’t making good use of its current assets.
Additional financial calculations, such as the quick ratio and the fixed charge coverage ratio, can help a company with its short-term asset management. These are commonly used as part of the underwriting process and part of the standard small business loan requirements of lenders.
Limitations of Net Working Capital Calculation
While calculating the NWC is important in determining the financial health of your business, there are some limitations to this calculation, such as:
- It might not accurately reflect cash flow: If your business has large current liabilities, like a line of credit, you might show a negative NWC despite the fact your business is meeting its obligations.
- It is only a snapshot in time of your financial health: This is why calculating change in NWC is so important. That will give you a longer-term picture of the financial stability of your business.
- It cannot account for accounting errors or external issues: If a company isn’t following sound accounting practices, or is dealing with such things as inventory theft or A/R companies going out of business, this number may not be an accurate picture of the company’s current financial state.
Ways to Increase Net Working Capital
There are a few solutions for a business looking to increase their NWC. You can consider the following options:
Sell Some Long-term Assets for Cash
Long-term assets such as equipment and machinery are not considered current assets. If your company has unused long-term assets it can spare, consider selling them for cash if those assets are still in good condition. Cash is a current asset and counts toward your NWC.
Increase Inventory Turnover
Look at where you can unload some of your surplus inventory so you don’t become overstocked. While inventory is a current asset, it’s not as liquid as cash and you can often sell your inventory at a premium. For example, if you are sitting on $10,000 worth of excess inventory but you can sell it for $15,000 in cash, your current assets will increase by $5,000.
Refinance Into Longer-term Debt
Short-term debts are current liabilities that are due within one year. If you have any short-term debts with higher interest rates, consider refinancing to a longer term. By doing this, the debt will no longer be included in the calculation of your NWC, aside from the total portion of principal due in one year. This will help increase your NWC by lowering the number of payments that are due.
Frequently Asked Questions (FAQs)
NWC can paint a picture regarding the current financial capacity your business has. It can help you to make business decisions that can promote growth, cash flow, and your ability to obtain financing by assessing your current assets and liabilities.
A good net working capital ratio is generally anywhere between 1.5 to 2. This demonstrates that a business is in good financial standing, and has the capacity to cover short-term liabilities using its current assets.
The formula to calculate NWC involves subtracting the current liabilities of a business from its current assets. Simply put, the equation is: Current assets – current liabilities = Net working capital.
Bottom Line
Net working capital can offer insight into whether or not a company is able to meet its current financial obligations. By evaluating its current assets and liabilities, a company can determine if its NWC is positive or negative. Keep in mind, this calculation is only one of many ways in which a company’s financial situation can be evaluated. You should take into consideration limitations and other ratios when determining the overall financial position of your business.
