What is the meaning of net working capital?
Net working capital (NWC) is the difference between a business’ short-term assets and its short-term debts and liabilities. It is ideal to have a positive net working capital, as this signifies that the company’s financial obligations are met, and it can invest in other operational requirements.
Net working capital = current assets (less cash) – current liabilities (less debt)
Here, current assets (CA) = The 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) = The sum of short-term liabilities that need to be paid off within the company’s operating cycle or a year.
A difference between the two thus presents the company’s liquidity, stating whether it holds sufficient assets to meet short-term liabilities.
For example, a company has the following CAs and 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 this case, NWC 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)
= 85,000 – 25,000
= Rs. 60,000
The company thus has a net working capital of Rs. 60,000, an amount that it can use for its short-term obligations.
In case of working capital deficits, you can avail additional funds to meet your liquidity requirement. Bajaj Finserv eases this concern with its high-value working capital loan, which is available against minimum eligibility.
Additional Read: Importance of capital budgeting
Components of working capital
Currently owned assets:
Current assets are monetary gains that a business has on hand, or expects to get in the next year:
- Cash and its equivalents: All the money that the business has on hand. This includes foreign cash and certain types of investments, like money market accounts
- Inventory: This includes everything from raw materials to unsold finished products
- Accounts receivable: This is a list of all cash claims for goods sold on credit
- Notes receivable: All claims to payment for other deals, made in writing
Current liabilities are all the debts that a company owes or is likely to owe in the next 12 months. Working capital helps figure out if a company can pay off all its bills with short-term assets it already has.
- Accounts payable: All unpaid bills to vendors for supplies, raw materials, utilities, property taxes, rent, or any other third-party running costs
- Payroll: All the staff's unpaid pay and salaries. Depending on when the company pays its employees (if they only get one paycheque a month), this may only add up to one month's worth of wages
- Long-term debts: All current payments on long-term debt
- Tax owed: These could be tax payments that are not due for a few months. But most of the time, these accruals are short term (due within the next 12 months)
- Dividend payable: All payments to owners that the board approves. A company can decide not to pay dividends in the future, but it must keep paying dividends that are already due
- Unearned revenue: Any money that comes in before the completion of work. If the company does not finish the job, the client may have to give back the money