Net working capital (NWC) is a financial metric used to measure a companys liquidity, operational efficiency, and short-term financial health. It is the difference between a companys current assets and current liabilities on its balance sheet. NWC is used to measure the short-term liquidity of a business and can also be used to obtain a general impression of the ability of company management to utilize assets in an efficient manner. A positive NWC is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses.
The formula for calculating NWC is:
Net Working Capital = Current Assets – Current Liabilities
It is important to note that there are different methods for calculating NWC, depending on what an analyst wants to include or exclude from the value.
Components of the working capital formula include:
- Current Assets: Short-term assets belonging to a company that can be converted into cash within the next twelve months, such as cash, accounts receivable, and inventory.
- Current Liabilities: Short-term debts and obligations that a company must pay within the next twelve months, such as accounts payable and debts.
Interpreting NWC:
- A positive NWC implies that a company has more current assets than current liabilities and thus has a positive net working capital balance.
- A negative NWC implies that a company has more current liabilities than current assets and thus has a negative net working capital balance.
- A tight working capital situation makes it quite unlikely that a business has the financial means to grow quickly.
