NWC is the short form for Net Working Capital. It is the amount required to meet all the short term expenses of the company, which includes the short term debts, everyday expenses, inventory and many more. It can also be termed as the difference between the current assets and the current liabilities, reflected in a balance sheet. Net Working capital is crucial for a company, to ensure that the company runs smoothly without any hurdles, for the coming year and meet all its financial obligations.
There is no hard and fast rule as to how much money a company should hold in stock to run smoothly. It depends on the liabilities of the company. For example, if you consider the case of a retail business, it is usually high during the holidays and certain times of the year. Hence, during those seasons the company’s expenses will spike than the offseason.
The calculation of a company’s working capital depends on its assets and liabilities. Current assets are the expenses the company holds – or in simple terms, that is the cash the company makes. Obligations, on the other hand, are the cash the company has to spend on payroll, taxes, rent and many others. For obvious reasons, the current liabilities should exceed the current assets. Inability to do so signals weak liquidity.
NWC= Current Assets – Current Liabilities
Working Capital ratio indicates the ratio of a businesses’ financial status. Formula for calculation:
Current liabilities/ current assets
If the ratio is above 2, then there is good liquidity and assets can be converted to cash. It ensures the companies stability.
If the ratio is between 1.2 to 2, then it remarks good liquidity of the company, although there is still room for improvement.
If the ratio is anything below the numbers as mentioned above, then it indicates a red flag, which requires immediate attention, to prevent the company from going under.
Why do you need working capital?
Although the reasons are pretty evident on this one, there are two particular scenarios when a company desperately needs working capital:
In case of crises shortly, to meet the financial needs of the company as well as the employees.
If a company is aiming for a big project, then it requires funding. Taking a loan is another option, but the procedure takes lots of time. Hence a good liquid flow in the company is right for its growth.
Ways to increase your capital
If you’re investing in a big project, the last thing you want is the project to halt due to monetary shortage. To prevent scenarios like that, you can request for an upfront deposit.
Set ground rules to speed up the money collected from their client companies or clients in general. This is the main reason a company can go under.
Ideal loans like the Small Business Administration (SBA) loans that are especially created to aid a company during the financial crisis.