What Is Net Working Capital?
Networking capital (NWC), is the difference between a company’s current assets, such as cash, accounts receivable and inventories of raw materials and finished goods, and its current liabilities, such as accounts payable.
Net operating working capital is a measure of a company's liquidity and refers to the difference between operating current assets and operating current liabilities.
In many issues, these computations are the same and are derived from company cash plus accounts receivable plus inventories, fewer accounts payable and less accrued expenses.
Working capital is a measure of a company's liquidity, operational efficiency and short-term economic character.
If a company has sufficient positive working capital, then it might have the potential to invest and improve. If a company's current assets do not exceed its current liabilities, then it may have a problem growing or giving back creditors, or even go bankrupt.
However, in some other cases like the educational industry, Networking Capital can be in minus, because like these types of industries there are no current assets as a retailer business.
The Formula for Working Capital
To calculate the working capital, compare a company's current assets to its current liabilities. Current assets listed on a company's balance sheet contain cash, accounts receivable, inventory and other assets that are expected to be liquidated or turned into cash in less than one year.
Current liabilities include accounts payable, wages, taxes payable, and the current portion of long-term debt.
Working capital that is in line with or greater than the industry average for a company of comparable size is mostly assumed acceptable but low working capital may reflect a risk of distress or default.
Working capital is computed by taking current assets and subtracting current liabilities.
For example, if a company has current assets of $200,000 and current liabilities of $150,000, then their working capital would be $50,000. Common examples of current assets include cash, accounts receivable, and inventory. Examples of current liabilities contain accounts payable, short-term debt payments, or the current portion of deferred revenues.
What is an example of working capital?
To illustrate, consider the case of ABC Corporation. When ABC first started, it had working capital of only $20,000, with current assets averaging $80,000 and current liabilities averaging $60,000. To enhance its working capital, ABC decided to keep more cash in reserve and slowly delay its payments to suppliers to reduce current liabilities.
After making these changes, ABC has current assets averaging $90,000 and current liabilities averaging $40,000. Its working capital is, therefore, $50,000.
Why is working capital essential?
Working capital is important because businesses must remain solvent.
As an assumption, a business could become bankrupt even if it is profitable. After all, an enterprise cannot rely on accounting incomes to pay its bills—those bills need to be paid in cash readily in hand.
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