Comprehensive Guide to Net Working Capital

Net Working Capital

In this post, we are going to study net working capital and all its related formulas and calculations. We are also covering the frequently asked questions about nwc and all terms and money matters of a company. Let’s start the step-by-step guide to net working capital.

 

Net working Capital Definition

The net working capital is the aggregate amount of money (not a ratio) that remains when we take out the total amount of current liabilities from the total current assets of the company or business. Do you know? Net working capital is also known as working capital. Hence, the formula for net working capital would be simply the difference between two things as shown below.

NWC= Current assets – Current liabilities

NWC= CA – CL 

here, CA represents current assets and CL being current liabilities. Below is an example!

Example

How do you calculate net working capital? Now, Let’s make a net working capital excel template and calculator for NWC.

NWC Calculator: Working-Capital-Template-Calculator

Define Current Assets!

A current asset is a company’s cash and its other present assets that are supposed to be converted into cash within one year (an operating cycle, maybe more than a year) of the date appearing in the heading of the company’s balance sheet. A balance sheet shows the organization’s financial position. Current assets are usually presented first on the company’s balance sheet.

What is Liabilities?

Current Liabilities is an obligation (debt) that will be due within one year (or the operating cycle of a company that can be more than a year) of the company’s balance sheet, and it requires the use of a current asset to be paid off or it will create another current liability.

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Working capital cycle:

The working capital cycle for a business is the operating cycle in which a company converts all its net working capital into cash money.  Most of the time, businesses try to manage the operating cycle by selling inventory quickly, raising profits from consumers fast, and then paying off bills slowly in order to optimize their cash flow.

working-capital-cycle

Steps-by-Step Calculations in Working Capital Cycle

For most companies, the working capital cycle or the operating cycle works as follows:

  1. The company purchases necessary materials, on credit, to create a product (Let’s say, the company have 120 days to pay off the suppliers for raw materials).
  2. Now, the company sells its inventory in 112 days, on average.
  3. The company receives payment from consumers for the products sold in 20 days, on average.
  4. All the cash received from customers is further utilized before paid off to suppliers.

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Working Capital Cycle Formula

What is NWC formula? Let’s make the simplest formula here.

Working Capital Cycle= Inventory Days + Receivable Days – Payable Days

An example will make things clear, let’s see!

Working Capital Cycle Example and Calculations Template!

Let’s calculate the operating cycle from the above example that we have. Now, that we know the steps in the cycle and the formula, let’s do the calculations for the above information.

Inventory days = 112
Receivable days = 20
Payable days = 120
Working Capital Cycle = 112 + 20 – 120 = 12

This means the company is only out of cash money for 12 days before receiving full payment.

Net working capital calculator

Let’s make a customizable calculator for net working capital so that you can calculate your own operating cycle.

working capital in excel sheet

NWC  Cycle calculator Attached: Working-Capital-Cycle-Calculator

Statement of changes in working capital

The statistics information relating to the variations in current natured accounts between two periods of time presented in the form of a statement is what we call the schedule/statement of changes in working capital.

Example of the statement of changes in working capital is attached: changes-in-working-capital

The following example shows the changes being reflected in the schedule.

statement-of-changes schedule

Types of working capital

There are two types of working capital cycles. Both of the types are explained below.

Positive working capital

When the value of the working capital cycle is positive it means that the company is out of cash for ‘X’ days before receiving full payment. ‘X’ is the working cycle. This is called positive working capital.

Negative working capital

When a business collects money faster than they off bills, a negative working capital cycle is generated and let’s see an example again. Sometimes, however, companies enjoy a negative working capital cycle where they collect money faster than they pay off bills for raw materials.

Sticking with the example we had earlier, consider that the company chooses to become a “cash only” business with its clients.  By only accepting cash money, its accounts receivable days become 0.

Let’s use the same formula again and calculate their new cycle time.

Inventory days = 112
Receivable days = 0
Payable days = 120
Working Capital Cycle = 112 + 0 – 120 = –8

Now, this means the company receives payment from clients and customers 8 days before it has to pay its suppliers.

What Is Working Capital Turnover?

Working capital turnover is a ratio that measures how efficiently a firm is using its working capital to sustain a given benchmark of sales. It is also referred to as net sales to working capital, work capital turnover gives the link between the funds used to finance a company’s operations and the profits a company generates as a result.

The Formula for Working Capital Turnover Is =  (Net Annual Sale)/(Average Working Capital)

WCT=NAS/NWC(average)

A high turnover ratio confirms that management is being very efficient in using a company’s short-term assets and liabilities for supporting sales.

In contrast, a low working capital turnover ratio may indicate that a business is investing in too many accounts receivable and inventory to support its sales, which could lead to an excessive amount of bad debts or obsolete inventory.

What is the working capital gap?

Working Capital Gap = Current Assets – Current Liabilities(Other than bank borrowings)

Following picture shows the example and calculations of the working capital gap!

what is working capital gap?

Net Working Capital Ratio

The net working capital (NWC) ratio measures the percentage of a company’s current assets to its short-term liabilities. Similar to net working capital, the NWC ratio can be used to determine whether or not you have enough current assets to cover your current liabilities.

The net working capital ratio can be calculated as follows:

(Current Assets) / (Current Liabilities)

The optimal ratio is to have between 1.2 – 2 times the amount of current assets to current liabilities. Anything higher could mean that a company isn’t making good use of its current assets. Liquidity measures such as the quick ratio and the working capital ratio can help a company with its short-term asset management

We hope that the concept is clearer now. You might also like Compound Interest Formula Excel (Complete Guide) If you have anything to add to this post, do let us know.

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