The liquidity calculation that measures a company’s position to pay off its existing liabilities with the existing assets is termed as net working capital. The net worth capital formula is focused on liabilities that should be repaid by the end of the current financial year like accounts payable, trade debts, vendor notes etc. much like the working capital ratio. Simply put, the net worth capital formula is the company’s ability to meet short term obligations and fund the normal functioning of a business.
There are different methods to calculate the net worth capital, some excluding cash and debt, and some including inventory accounts payable and accounts receivable. According to what the analyst wants to include or exclude, there are different methods for the calculation of Net Worth Capital.
Net Worth Capital (NWC) = Existing Assets – Existing Liabilities
Net Worth Capital (NWC) = Existing Assets (less cash) – Existing Liabilities (less debt)
Net Worth Capital (NWC) = Accounts Receivable – Accounts Payable + Inventory
The first formula in the formulae mentioned above is the most broadly defined formula, with the next two becoming increasingly narrower depending on what is to be included.
What Current Assets & Liabilities Are
Typically, the current assets that are considered while formulating net worth capital are cash, short term investments, accounts receivable and inventory.
The current liabilities usually include accrued expenses, accounts payable, customer deposits, taxes, trade debt etc.
Long Term Assets
The company will be forced to use its long term assets if it cannot meet its current liabilities with current assets. This can have serious implications, leading to severe financial and economic problems within the company due to reduced sales and operation.
Some analysts also choose to include the current section of long term debt in the current liabilities section, which makes sense, because even though the current debt may come from a long term obligation, it may have to be repaid in the current year.
What Net Worth Capital Is Used For
A positive net worth capital could show investors and creditors that the company has enough assets to pay off its current debts. A very high NWC can also mean that the company has enough assets to expand further without taking on additional debt from other investors. A negative NWC indicates that the company has more debts than it can afford to have. It means that its current assets are not matching up to their current liabilities and that if this continues, they may have to sell their long term assets to overcome their current debts. So obviously, a positive NWC is what a company should be aiming for.