Owning a company will introduce you to many different facets of the world that you haven’t witnessed. As you manage your business, several such aspects make up for the complete picture of your success. Net working capital would be one such term that you must have come across that has an integral part in your business. As you sit through the accounting of your company’s monetary transactions and deals, you will surely have to calculate the net working capital to determine the current state of the business.
In the simplest terms, Net Working Capital (NWC) can be defined as the difference between the current assets and current liabilities of a company. It is considered as the record of the company’s liquidity, fund operations, and the ability of the company to meet short-term obligations. Having a positive net working capital balance is the ideal position for any company, meaning that they must have more current assets than liabilities. Let us have a closer look at net working capital and its relevance in a company’s life.
Importance of Net Working Capital
As mentioned earlier, by having a clear idea of a business’s NWC will help you gain more knowledge about the liquidity of the funds of a company and if they have enough funds to pay off the current short-term obligations. If a company has net working capital to be zero or greater, the business is quite stable to cover the debts. All companies should have enough capital all year round to cover such short-term bills.
Having a large capital figure puts the business at a more prepared and established state to remain stable even when they have existing obligations. Net working capital can be used to compare the change of figures over time and build a trend in your business’s liquidity accordingly. It can imply how well your company can grow in the future; whether the current state will continue longer and improve or decline. By having significant capital reserves, a business may be able to scale its operations easily and swiftly.
Improving Net Working Capital
Some changes can be made to the operations of a company to improve its liquidity, and consequently, its NWC value. Shortening your billing cycle and ensuring frequent payments by the customers can be made possible by changing your payment terms. Make sure that you follow up with the clients just when the invoice is due. That can help you with collecting the late payment more quickly. One of the major steps taken by many of the companies is of returning the unused inventory to the vendors. By doing so, the companies will receive a refund for the cost of the items in it; be it machinery or other equipment. Another small step to improve working capital is of lengthening the payment period for the vendors. You can do that only if they allow you to, without charging any fees for the late payment.