Net Working Capital Definition Formula How To Calculate

Net Working Capital Definition

In simple terms, net working capital (NWC) denotes the short term liquidity of a company. It is calculated as the difference between the total current assets and the total current liabilities.

Net Working Capital Formula

Let’s have a look at the formula –

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There are two important elements.

The first element is the current assets. Current assets are those assets that can liquidate within one year or less. That means current assets will pay you off for less than a year. We can give examples of current assets as sundry debtors, accounts receivables, inventories, prepaid salaries, etc.The second element is the current liabilities. Current liabilities are those liabilities that can pay off for less than a year. Examples of current liabilities are sundry creditors accounts payablesAccounts PayablesAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more, outstanding rent, etc.

Example

Let’s take a practical example of networking capital formula.

Tully Company has the following information –

Sundry Creditors – $45,000Sundry Debtors – $55,000Inventories – $40,000Prepaid salaries – $15,000Outstanding advertisements – $5000

Find out the NWC of Tully Company.

We have been given both current assets and current liabilities in the above example.

First, we need to separate the current assets from the current liabilities.

Then we need to total the current assets and also the current liabilities. And then, we need to find the difference between the current assets and the current liabilities.

Current Assets – Sundry Debtors, Inventories, Prepaid salaries;Current Liabilities – Sundry Creditors, Outstanding advertisements.

Total current assets = (Sundry Debtors + Inventories + Prepaid salaries) = ($55,000 + $40,000 – $15,000) = $110,000.

Total current liabilities = (Sundry Creditors + Outstanding advertisements) = ($45,000 + $5000) = $50,000.

The Net Working Capital Formula is –

Total Current AssetsTotal Current AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more – Total Current LiabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They’re usually salaries payable, expense payable, short term loans etc.read more = $110,000 – $50,000 = $60,000.

Colgate Example

Below is the Balance Sheet Snapshot of Colgate’s 2016 and 2015 financials.

Let us do the Calculation for Colgate

NWC (2016)

Current Assets (2016) = 4,338Current Liabilities (2016) = 3,305NWC (2016) = 4,338 – 3,305 = $ 1,033 million

NWC (2015)

Current Assets (2015) = 4,384Current Liabilities (2015) = 3,534NWC (2015) = 4,384 – 3,534 = $850 million

Use of Net Working Capital

Investors use NWC to know whether a company is liquid enough to pay off its short-term liabilities. If you look at current assets and current liabilities, you will find them on the balance sheet. That’s why NWC needs to be interpreted properly.

There are two ways through which we can interpret NWC.

When the NWC is positive, the investors can understand that the company has enough current assets to pay off its current liabilities.And when the NWC is negative, the investors can comprehend that the company doesn’t have enough assets to pay off its current liabilities.

Investors can also see the usefulness of NWC in calculating the free cash flow to firm and free cash flow to equityFree Cash Flow To EquityFCFE (Free Cash Flow to Equity) determines the remaining cash with the company’s investors or equity shareholders after extending funds for debt repayment, interest payment and reinvestment. It is an indicator of the company’s equity capital managementread more. But if there is an increase in the NWC, it isn’t considered positive; rather, it’s called negative cash flow. And obviously, this increased working capital is not available for equity.

Net Working Capital Calculator

You can use the following calculator

Net Working Capital Formula in Excel (with excel template)

Let us now do the same example above in Excel. It is very simple. You need to provide the two inputs of Total Current Assets and Total Current Liabilities.

You can easily do the Calculation in the template provided.

Net Working Capital Definition Formula How To Calculate