What is Net Working Capital How to Calculate Definition, Formula, Ratio

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net working capital

There’s always a time when the Net Working Capital of a business is affected in the business, it is needed to support additional investments in the business and also to track down the profitability and workings of the business. So, let us understand net working capital investment a more with its negative net working capital and positive net working capital, its formula, and more.

What is net working capital?

net working capital is defined as the difference that exists between a company’s current assets, which includes cash, accounts receivables, inventories of raw materials as well as of finished goods, and a company’s current liabilities that include accounts payable. So, networking capital includes the company’s current assets and a company’s current liabilities.

Thus, you can also say that net operating working capital is a financial measure that tells us if a business has enough funds available to pay off its debts and all its liabilities.

Net working capital formula:

Calculating networking capital involves the following net operating working capital formula as:

  • Working capital = Current Assets – Current Liabilities

By comparing a company’s current assets to its current liabilities you can know the change in net working capital.

Thus, the formula of the net working capital equation tells us the remaining short term liquid assets after the payment of after short term liabilities.

net working capital

Modifications to the working capital formula

You can even use the net-working capital formula in different ways as:

  • Working capital = Current Assets – Cash – Current Liabilities (omits cash)
  • Working capital = Accounts Receivable + Inventory – Accounts Payable (this symbolizes merely the “fundamental” accounts that make up working capital in the business)
  • NWC = Accounts Receivable + Inventory – Accounts Payable

Key Points to know:

  • Working capital is associated to the current ratio.
  • The Working capital equation tells you about the current assets on hand after you pay all your debts and obligations within the next year.
  • You can know how well a company can ensure its short-term liabilities in the business.
  • Having a high Working capital is not always a good sign to be noticed.

Types of Working capital:

There exist 2 type of working net capital as we have mentioned below that is ultimately a result of changes in current asset and current liability of a business. 

  1. Positive working capital: When there are enough current assets in the business, where a company can fund its current operations and make purchases and future investments as well.
  2. negative working capital: When the current liabilities exceed the current assets or say short-term debt is more than the short-term assets than their exit negative working capital.

How to calculate net working capital?

To calculate the working capital net you need to find the current assets and current liabilities in the balance sheet. By finding the current assets and current liabilities you can get net-working capital ratio or the net working capital.

So, here you know how to find working capital net by the net operating working capital formula as:

  • Net Working capital = Current Assets – Current Liabilities

Here, the higher the net-working capital ratio the more flexibility to expand your business operations. And if the changes in networking capital or its ratio are less than 1:1 than it means the business is facing difficulty in expanding its business and paying its bills.

Net Working Capital Ratio:

As, we know the Net Working capital Ratio is affected by current assets and the current liabilities, which in all result in a change in Net Working which can be seen in respect to one as follows:

  • The Current Ratio is <1: Here we have the current ratio of less than one where we will see negative Net Working Capital.
  • Current Ratio is =1: Here we have the current ratio equal to one where we will see zero Net Working Capital.
  • Current Ratio is >1: Here we have the current ratio of more than one where we will see positive Net Working Capital.

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Example of Net Working Capital Ratio:

You are given 3 different cases as follows for calculation of the Net Working Capital ratio. From which we will see the resulting Working Capital Net ratio as positive, negative, and zero. 

Particulars Case 1 Case 2 Case 3
A. Current Assets Amount ( in $ ) Amount ( in $ ) Amount ( in $ )
Inventory 5000 52000 10000
Debtors 15000 17000 20000
Bills Receivable 14650 29000 6000
Cash in hand 2000 42000 19000
Cash at bank 1500 120,000 25000
A1. GROSS WORKING CAPITAL/TOTAL CURRENT ASSETS 38,150 260,000 80,000
B. Current Liabilities Amount ( in $ ) Amount ( in $ ) Amount ( in $ )
Creditors 15000 190,000 12500
Bills Payable 5000 41,500 8900
Bank Overdraft 42500 28,500 24560
B1. Total Current Liabilities 62,500 260,000 45,960
Current ratio (current assets / current liabilities) 0.6104 1 1.740
Net-working capital (A1 – B1) – $ 24,350 0 $ 34040

Net-working capital to sales ratio:

The net-working capital to sales ratio is also known by the name as a working capital turnover ratio which you can find out by dividing net annual sales by the average amount of working capital that we usually calculate for a period of 1 year or 12 months.

What Moves Net Working Capital?

A change in net-working capital either of assets or liabilities will cause a change in net working capital. There will not be any change notice in the operating working capital only when the current assets and current liabilities are equal.

You can also notice the Net Working Capital change by:

  • Increasing of Net Working Capital: An increase of After Deductions Working Capital means that the business has increased current assets or has decreased current liabilities by paying off its liabilities.
  • Decrease of Net Working Capital: A decrease of After Deductions Working Capital means the business has an excess of liabilities over its current assets. The business has more debts and payments to be made off than the assets and investments in the business.

Net-working capital Examples:

  1. Example 1:  Company XYZ has the following values of current assets and the Current liabilities for the year 2019 and 2020. You ought to calculate its Change in Net Working Capital.

Current Assets As:

Description 2019 2020
Account Receivables $ 20,000 $ 25000
Inventory $ 10000 $ 15000
Other Current Assets $ 12000 $ 10000
Total Current Assets $ 42000 $ 50000

Current Liabilities As:

Description 2019 2020
Accounts Payables $ 5000 $ 3000
Prepaid Expenses $ 1500 $ 2000
Other Current Liabilities $ 4000 $ 3500
Total Current Liabilities $ 10500 $ 8500

Solution:

We have the formula as

Net Working capital = Current Assets – Current Liabilities

For 2019:

Working Capital = $ 42000 – $ 10500

= $ 31500

For 2020:

Working Capital = $ 50000 – $ 8500

= $ 41500

Change in Net Working Capital is premeditated using the formula given below as, 

Working Capital for Current Period –Working Capital for Previous Period

Change in Working Capital = Working Capital for 2020 – Working Capital for 2019

= $ 41500 – $ 31500

So, the Change in Working Capital Net = $ 10,000

As, the change in the working capital net is more or has increased, which tells us that change in current assets is more than a change in current liabilities. Which tells us about the cash outflow of the company. 

This can be represented in excel as:

A B C
1 Current Assets As:
2 Description 2019 2020
3 Account Receivables $ 20,000 $ 25000
4 Inventory $ 10000 $ 15000
5 Other Current Assets $ 12000 $ 10000
6 Total Current Assets $ 42000 $ 50000
7 Current Liabilities As:
8 Description 2019 2020
9 Accounts Payables $ 5000 $ 3000
10 Prepaid Expenses $ 1500 $ 2000
11 Other Current Liabilities $ 4000 $ 3500
12 Total Current Liabilities $ 10500 $ 8500
13
14 Net Working Capital = Current Assets – Current Liabilities Current Assets – Current Liabilities
15 = (B5 – B12) = (C5 – C12)
16 $ 31500 $ 41500
17 Change in Net-working Capital Formula  Net Working Capital for 2020 – Net Working Capital for 2019
18 = (C16 – B16)
19 = $ 41500 – $ 31500
20 $ 10,000

Example 2: Given to us the following information as: 

Cash & cash equivalents: $ 10,000 and Inventory: $ 5000 and Marketable investments: $ 4000 and Trade accounts receivable: $ 2000 and Trade accounts payable: $ 11000. 

Description Amount
Cash & cash equivalents $ 10,000
Inventory $ 5000
Marketable investments $ 4000
Trade accounts receivable $ 2000
Trade accounts payable $ 11000

Solution: 

Net Working Capital = Cash & cash equivalents + Inventory + Marketable investments + Trade accounts receivable – Trade accounts payable

= $ 10,000 + $ 5000 + $ 4000 + $ 2000 – $ 11000

= $ 10,000

We can calculate Net Working Capital in excel as follows:

A B
1 Description Amount
2 Cash & cash equivalents $ 10,000
3 Inventory $ 5000
4 Marketable investments $ 4000
5 Trade accounts receivable $ 2000
6 Trade accounts payable $ 11000
7 =SUM(B2:B3:B4:B5) – B6
8 Net Working Capital $ 10,000

Example 3: We have the following balance sheet of ABC Ltd company which tells us the current liabilities and current assets of the company as follows:

Current Assets Year 2019 Year 2020
Cash & Cash Equivalents  $ 4,00,000 $ 5,00,000
Short term Investments $ 32,000 $ 42,000
Net Receivables $ 2,00,000 $ 1,00,000
Inventory $ 20,000 $ 50,000
Other Current Assets $ 4,50,000 $ 3,40,000
Total Current Assets $ 1,102,000 $ 1,032,000
Long Term Investments $ 50,000 $ 57,000
Goodwill $ 2,00,000 $ 1,00,000
Property Plant & Equipment $ 20,000 $ 50,000
Intangible assets $ 4,00,000 $ 5,00,000
Other assets $ 20,000 $ 50,000
Current Liabilities Year 2019 Year 2020
Account payables $ 50,000 $ 40,000
Current long term debt $ 32,000 $ 42,000
Other current liabilities $ 1,40,000 $ 1,20,000
Total current liabilities $ 222,000 $ 202,000

You need to calculate the working capital net of ABC Ltd. 

Solution:

Working Capital Net is calculated using the formula given below

Net Working Capital = Current Assets – Current Liabilities

So, we have total current assets for year 2019 = $ 1,102,000

total current assets for year 2020 = $ 1,032,000

And also we have total current liabilities for the year 2019 = $ 222,000

total current liabilities for the year 2020 =$ 202,000

So, with the help of formula, we will calculate net operating capital as:

For the Year 2019: 

= $ 1,102,000 – $ 222,000

For the Year 2020: 

= $ 1,032,000 – $ 202,000

  • Change in Net Working Capital = Net Working Capital for Current Period – Net Working Capital for Previous Period

Change in Net Working Capital = Net Working Capital for 2020 – Net Working Capital for 2019

= $ 8,30,000 – $ 8,80,000

= ($ 50,000)

Here, we have a negative net working capital

That we have in the following calculation in excel as follows:

7 Total Current Assets $ 1,102,000 $ 1,032,000
12 Total current liabilities $ 222,000 $ 202,000

So, with the help of formula, we will calculate net operating capital as:

 

Net Working Capital = Current Assets – Current Liabilities

A B
7 Total Current Assets $ 1,102,000 $ 1,032,000
12 Total current liabilities $ 222,000 $ 202,000
13 =B7-B12 =C7-C12
14 $ 8,80,000 $ 8,30,000
15 Change in Net Working Capital Net Working Capital for 2020 – Net Working Capital for 2019
16 = (C14-B14)
– $ 50,000

Net-working capital calculator:

You can also use a net-working capital calculator for calculating the operating capital of the company directly by using some online net working capital calculator tools.

working capital vs net working capital:

There are 2 classes of working capital and the 2 classes are: 

  1. Gross Working Capital: The sum or the total of all current assets is known to be as Gross Working Capital.
  2. Net Working Capital: While the difference exists between the sum total of current assets and the total of current liabilities is known to be Net Working Capital.

Conclusion:

By reading the detailed working capital article above you will get to know net working capital adjustment and all its related information with formula, ratio increase and decrease, and why it is important as well. 

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Frequently Asked Questions 

What is the difference between net working capital and working capital?

The sum or the total of all current assets is known to be as Gross Working Capital. While the difference exists between the sum total of current assets and the total of current liabilities is known to be as Working Capital Net.

Why Net working capital is important?

Working Capital tells us about the company’s or business condition as well as its liquidity or say its current assets and current liabilities by which we know the profitability of the business. 

How to calculate the change in net working capital?

The change in net working capital is find out by subtracting the previous year capital working from the current year capital working, Thus, the formal is as follows:

Change in Net Working Capital = Net Working Capital for Current Period – Net Working Capital for Previous Period

How do you calculate net working capital?

In order to calculate the working capital net, you firstly need to know the current assets as well as the current liabilities of the business or the company. And then by subtracting current liabilities from the current assets you will get the working capital net. Thus, the formula for the same is as follows:

Working Capital Net = Current Assets –  Current Liabilities

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