Net Working Capital Formula | Example Calculation | Ratio

Net Working Capital (NWC)

Networking capital ratio is used to measure the ability of the company to pay off its Net Working Capital (NWC)current liabilities with current assets.

For the management, general creditor, and for the Vendors NWC calculation is very important because this ratio shows the short term liquidity of the firm and also NWC used to find the efficiency of the management to use the assets of the firm.

Lie working capital ratio, net working capital (NWC) formula focus on the current liabilities of the business such as account payable, trade debt, and vendor notes that must be repaid in the current year.

Through these investors and vendors find how much current assets are available in the company which may be converted into cash for the payment of liabilities which are due for the next 12 month.

For the payment of the obligation of the company, if the company has not enough current assets then company forced to sell its long term assets or income producing assets for the payment of the current obligation.

Formula

Net working capital, NWC formula can be calculated by subtracting the current liabilities from the current assets f the business.

 Net Working Capital = Current Assets – Current Liabilities

Current assets in the net working capital are cash, account receivable, inventory, and short term investment.

In the net working capital, current liabilities include account payable, customer deposit, taxes, and other trade debt.

Example

Now we take the example of Lara’s clothing store. Current assets and liabilities for Lara’s store are listed below.

  • Cash = 10,000 dollars
  • Account Receivable 5,000 dollars
  • Inventory = 15,000 dollars
  • Account payable = 7,500 dollars
  • Accrued expenses = 2,500 dollars
  • Other trade debt = 5,000 dollars

From net working capital (NWC) calculator Lara can calculate the measurement like this

Net Working Capital

$15,000 = $30,000 – $15,000

From the above result, it is clear that the current assets of Lara are greater than the current liabilities.

NWC for the Lara is positive so for the short term his store is very liquid because of which he can expand his business or invest into new business.

Analysis

What is Net Working Capital Used For?

Positive Net WC is better than Negative WC because positive net WC shows that the company has more current assets than its current liabilities. From the positive net WC, investors and creditors know that the company can easily pay off its current obligations through its operations.

If the measurement is large positive it means that the company can expand its business without taking debt or investors.

What is Negative Net Working Capital?

If the networking capital of the company is negative then it shows to investors and creditors that, the company not producing enough to support the current debt of the company.

Because of the negative number company needs to sell its long term assets or income producing assets for the payment of the current obligations of the company. If the negative trend of the company continues then company declaring bankruptcy.

The positive number is better than the negative number in net WC. Negative numbers don’t indicate that the company is going under. it means that the short term liquidity of the company is not good.

For the creation of sustainable business, there are many factors. For example, if the company convert more of its inventory into cash it not means that the company Has a positive number. If the current assets are greater then liabilities then the company has a positive number.

A company with positive NWC not considered the positive view if its trend down day by day. Whereas a company with negative NWC considered as a positive view if its trend improves day by day.

Change in Net Working Capital

Many people ask ” how does a company change its net working capital over time?” For the improving of the liquidity of the company, there are 3 main ways.

First is the company can decrease its receivable collection time.

In the second step, the company can reduce the amount of carrying the inventory by sending back unmarketable goods to suppliers.

For long account payment term payable company negotiate with vendors and suppliers in the third step.

These 3 steps improve the short term liquidity of the company.

For more Financial Ratio Check: 

Net operating income (NOI)

Net present value (NPV)

Net profit margin

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