What Is Net Working Capital? With Definitions And Formulas

You can calculate a company’s net working capital by subtracting its current liabilities from its current assets. When a company’s assets are less than its total current liabilities, it may have trouble paying creditors. If a company’s change in NWC has increased year-over-year (YoY), this implies that either its operating assets have grown and/or its operating liabilities have declined from the preceding period. Because the interpretation of a company’s working capital can vary so widely, it is important to consider this metric in a historical context by noting patterns of increasing or decreasing figures over time.

There are multiple ways to favorably alter the amount of net working capital. One option is to require customers to pay within a shorter period of time. However, this can be difficult when customers are large and powerful. Another options is to be more active in collecting outstanding accounts receivable, though there is a risk of annoying customers when collection activities are overly aggressive. A third option is to engage in just-in-time inventory purchases to reduce the inventory investment, though this can increase delivery costs.

Q. Can a negative NWC always indicate financial trouble?

For one, it can indicate a company’s potential to grow and invest and avoid bad trade debt. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates nwc meaning and cheat sheets. Likewise, the change should be positive (“cash inflow”) if the NWC is declining year-over-year. Positive working capital can have a range of interpretations depending on the actual figure, the industry the business is in, and the specific business itself.

Additionally, accountants can calculate and track NWC for clients with ease because accountants create financial statements that show the details needed for the NWC formula. Typically, other current assets and liabilities represent a relatively small portion of a company’s assets and liabilities. Hence, they won’t impact working capital as much as accounts receivable or payable. Create subtotals for total non-cash current assets and total non-debt current liabilities. Subtract the latter from the former to create a final total for net working capital. If the following will be valuable, create another line to calculate the increase or decrease of net working capital in the current period from the previous period.

Quality of Current Assets and Completeness/Adequacy of Current Liabilities

It is also necessary to compare a company’s working capital figure to that of similar businesses within the same industry to ensure a fair and accurate analysis of its operational efficiency. A high working capital ratio is not always a good thing for business. This indicates the business has too many inventories and is struggling to sell those.

Net Working Capital (NWC) stands as a critical metric for assessing a company’s short-term financial health. Understanding the intricacies of its formula, components, and limitations provides valuable insights into a firm’s liquidity and operational efficiency. Conversely, a working capital ratio below one can be a cause for concern. The working capital ratio uses the current ratio, another liquidity metric, and represents the function between current assets and current liabilities.