Net Working Capital: Definition, Formula, Example

Net Working Capital or NWC helps you identify the difference between debts and assets. It helps businesses to determine the current financial health of their company. Once they know where they are standing financially, it helps them to make an informed decision about their short-term investment. The information that NWC offers can also help businesses to prepare a budget that can be helpful in the long run.

In this article, we will be talking about what Net Working Capital is, how it works, how to calculate it, and some examples. So if you want to learn the basics of NWC, this article is for you.

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Table of Contents

What is Net Working Capital?

In accounting, net working capital is defined as a firm’s difference between its total assets and its total liabilities. In other words, NWC measures a company’s short-term resources in terms of how easily they can be converted into cash. This helps managers to determine whether or not they are about to face liquidity problems or if they are likely to meet their short-term liabilities with ease.

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When it comes to assets it includes cash, accounts receivable, inventory, etc. And now when it comes to liabilities it includes accounts payable, wages, taxes payable, debts, etc.

How to calculate NWC

Calculating NWC is not that hard. The first thing you need to know is how to calculate the value of short-term assets and liabilities.

Formula:

Net Working Capital = Current assets – Current liabilities

The current assets are the assets that can be turned into cash within a short period And the current liabilities are the short-term debts that need to be paid soon.

Companies need to know how much money they have in the bank, because if something happens and they run out of cash then they will not be able to continue their operations which might lead them to bankruptcy. That is why they need to calculate the net working capital of their company regularly.

Example

Assume that you own a company named ABC Inc. which manufactures and sells goods. For this, your business requires raw materials to produce the products. Additionally, at the time of sale, you will need money to pay for salaries, taxes, etc. You can use the formula above to calculate your NWC i.e current assets-current liabilities.

Now let’s say that your short-term assets are $ 100,000 and your short-term liabilities are $ 50,000. You can calculate your NWC as

NWC = Current Assets – Current Liabilities = $100,00 – $50,000 = $50,000

In this example ABC Inc.’s networking capital is $50,000.

Why Net Working Capital is important

Net Working Capital is important because it represents a company’s ability to pay its short-term obligations. A company with a positive net working capital has more short-term assets than liabilities, and can therefore use those assets to pay its bills. A company with a negative net working capital has more liabilities than assets, and may not be able to pay its short-term obligations. A company can use its Net Working Capital to finance its operations, expand its business, or make acquisitions. It can also use it to pay dividends, buy back stock, or reduce its debt. Net Working Capital is an important indicator of a company’s financial health.

Conclusion

NWC or Net Working Capital helps businesses to determine the financial health of their company at a given time. It can tell managers whether or not their company is about to face liquidity problems, and help them plan accordingly. Without the proper information, one could run into serious problems such as running out of money and going bankrupt.