Every business will have plenty of liabilities created over a certain period of time. In order to manage a company, all aspects have to be considered when handling finances. Net working capital is also one such element that plays a crucial role in determining a company’s potential to rise above its current status. Net working capital is defined as the difference between the current assets and liabilities of a company. This is a value that indicates the funds a company has in store to tackle the financial challenges. If the net working capital is positive, it means the company has sufficient funds to meet all the obligations and make safe investments. On the other hand, if the value is negative, it simply indicates the adverse conditions the company is going through at that point. Let us look at more about net working capital, its calculations, and its effects.
Net Working Capital
As stated earlier, net working capital is the difference between the assets and liabilities of a company, and it is the value determining the company’s financial stability. The concept can be easily understood when considering it with values. If the current assets are $50,000 and current liabilities are $45,000, the NWC stands at $5,000. This is the case in which assets are higher than liabilities. The opposite could also happen, indicating the downfall of a business. NWC can be easily calculated using the following formula.
Net Working Capital = (Trade Accounts Receivable) + (Cash) + (Inventory) + (Marketable Investments) – (Trade Accounts Payable)
This is a breakdown of the basic formula that is a simple translation of the definition.
Net Working Capital = (Current Assets) – (Current Liabilities)
Learning the concept of net working capital is easy since it only takes an example to comprehend the multiple factors involved.
Any short-term assets that can be converted to cash in a year or less are categorized as the current assets of a company. These would usually include commercial paper, cash, cash equivalents like treasury bills, money market funds, government bonds, inventories, marketable securities, and accounts receivable. Simply adding the values of all these will give you the total current assets owned by your company. Summing up these values will build a tentative NWC that may or may not result in the way you anticipated.
All short-term financial obligations that are due in a year or less are considered current liabilities. Short-term loans, accrued liabilities, lines of credit, credit cards, vendor notes, trade debts, accounts payable, small business loans, and commercial real estate loans are current liabilities that every company must pay back in the imminent months. Summing up these debts will amount to the right liability value.
Once you have found the total value of current assets and current liabilities, all you need to do is subtract the latter from the former.