Net Working Capital

What is Net Working Capital?

The operational capital of a company is referred to as its working capital. Such a capital enables the organisation to run its operations smoothly, forming the life-blood of the business.

Net working capital (NWC) is the difference between the debts owed to a company, and the debts owed by it during the course of its operation. The debts owed to a company or the current assets include debtors, inventory, cash and prepaid expenses, and the debts owed by a company or current liabilities include creditors and outstanding expenses. Now that we know what does the net working capital means, let’s understand what this difference indicates:

• A positive net working capital signifies that the company’s financial obligations are met and that it can invest in other operational requirements
• A net working capital that is nil means that a company has just the amount of funds to clear its current financial obligations.
• A negative net working capital implies that the company requires further debts to meet its current liabilities.

A good working capital ratio ranges between 1.2 to 2.

However, these parameters aren’t definitive indicators of the overall financial health of a company. At times, sudden financial contingencies might require an increase in short-term debt. Also, a positive figure for net working capital could imply a blockage of cash in assets that aren’t easily convertible.
 

Importance of Net Working Capital

 
Adequate net working capital (NWC) is essential for smooth day-to-day operations of a business. Regardless of the size of operations, all organisations consider working capital (WC) as a critical metric to determine the efficiency of contributions to the operating liquidity of a company.

Measurement of net working capital (NWC) allows a business to assess whether its current assets are sufficient to meet current liabilities. A positive WC means the business can allocate the excess amount for operation optimisation. A deficit in WC, however, calls for capital infusion in the business to maintain liquidity.

For a business to operate smoothly, it must have adequate liquidity to fund its short-term operations. That’s why Bajaj Finserv offers working capital loans up to Rs.45 lakh to help focus on your business growth and not worry about finances.

 

Net Working Capital (NWC) Formula

 Net working capital as business can be calculated as the difference between its short-term assets and its short-term debts & liabilities. The formula to calculate the net working capital is -

Net Working Capital = Current Assets (less cash) – Current Liabilities (less debt)

Here,

Current Assets (CA) = A sum of all short-term assets that are easily convertible into cash like accounts receivable, debts owed to the company, etc. It also includes available cash.
  Current Liabilities (CL) = A sum of short-term liabilities that need to be paid off within a company’s operating cycle or a year.

How to Calculate Net Working Capital

A difference between the two thus presents the company’s liquidity, stating whether it holds sufficient assets to meet short-term liabilities.

An alternate Net Working Capital Formula to calculate NWC is:
NWC = Accounts Receivable + Inventory – Accounts Payable

Where account receivables and inventory are the current assets of a company and account payables are the current liabilities.

Let's understand how to calculate net working capital with an example, when a company has the following Current Assets (CAs) and Current Liabilities (CLs) in its balance sheet.

• Inventories – Rs.40,000
• Accounts receivables – Rs.50,000
• Cash – Rs.10,000
• Debtors – Rs.5,000
• Creditors – Rs.10,000
• Short-term loans – Rs.30,000
• Income Tax – Rs.5,000

In that case, net working capital will be calculated as follows –

NWC = CA – CL

= (Inventories + accounts receivables + Debtors – cash) – (Short-term loans + Income Tax – Creditors)
= (40,000 + 50,000 + 5,000 – 10,000) – (30,000 + 5,000 – 10,000)
= 95,000 – 25,000
= Rs.70,000

The company thus has a net working capital of Rs.70,000, an amount that can sufficiently meet its short-term liabilities.

In case of deficits, businesses must make sure to avail additional finance that helps meet the liquidity requirement. Bajaj Finserv eases this concern of companies with its high-value Working Capital Loan available against minimum eligibility.