What Is Net Working Capital?
Net Working capital (NWC) is calculated by subtracting a company’s current liabilities from its current assets. This equation is used to measure a company’s liquidity and short term health.
What Does Net Working Capital Tell Investors?
Both creditors and investors who are analyzing a company may want to calculate its NWC. NWC will tell analysts a great deal about a company’s ability to meet short term obligations using only its most liquid assets. A company with a large NWC surplus may also be in a position to invest its capital and continue growth/expansion. However, it is important to remember that companies in different industries have unique capital structures. So, NWC is best analyzed on a case-to-case basis.
Net Working Capital Calculation
As stated before, net working capital is calculated by subtracting a company’s current liabilities from its current assets. This concept is made clear with the formula below.
Net Working Capital = Current Assets – Current Liabilities
The components that make up both current assets and current liabilities are found on a company’s balance. A positive net working capital implies that a company could meet all its short-term obligations only using its most liquid assets. Analyzing NWC in this matter is similar to the way investors analyze the current ratio.
Components Of Net Working Capital
To better understand how companies may utilize NWC, one must understand the components of both current assets & liabilities. Below is a list of a few key components of each of these categories.
Current Assets
- Cash & Equivalents
- Accounts Receivables
- Pre-Paid Expenses
- Inventory
Current Liabilities
- Current Portion Of Long Term Debt
- Wages Payable
- Accounts Payable
- Dividend Payable
Limitations Of Net Working Capital
One limitation of NWC is the lack of up-to-date data available to investors that is necessary to accurately calculate it. Many components of current assets & liabilities are subject to change quickly and certainly within a quarter. However, investors only have access to the data that was provided in the most recent company report. Another limitation is the lack of specificity. For example, a company may be struggling to sell its inventory and in turn has a valuable yet illiquid inventories that will not be easily liquidated to meet obligations. Also, assets on a balance sheet are subject to be inaccurately valued. In the event of necessary liquidation, current assets may not be able to be liquidated at book value, thus rendering previous NWC calculations inaccurate.
