Net working capital, or sometimes just "working capital", refers to short-term assets left after deducting short-term liabilities. In other words, it shows how much current assets the company would have left if it had to use them to settle all of its current liabilities.
The net working capital is calculated by simply deducting all current liabilities from all current assets.
Net working capital = Current assets – Current liabilities
Current assets refer to resources that are short-term in nature. Meaning, they include cash and other resources that are easily convertible into cash (i.e., within 12 months or the normal operating cycle, whichever is longer). Current assets include: cash and cash equivalents, marketable securities, short-term receivables, inventories, and prepayments.
Current liabilities are those that mature in the short-run. They are to be settled within 12 months or the normal operating cycle. Current liabilities include accounts payable, short-term notes payable, current tax payable, accrued expenses, and other short-term payables.
The following information has been taken from the balance sheet of ABC Company.
| Current assets: | ||
| Cash and cash equivalents | $ 100,000 | |
| Marketable securities | 170,000 | |
| Trade and other receivables | 200,000 | |
| Inventories | 400,000 | |
| Prepayments | 80,000 | |
| Total current assets | $ 950,000 | |
| Non-current assets: | ||
| Long-term investments | $ 400,000 | |
| Fixed assets | 1,200,000 | |
| Total current assets | $ 1,700,000 | |
| TOTAL ASSETS | $ 2,650,000 | |
| Current liabilities | $ 520,000 |
| Non-current liabilities | 1,150,000 |
| Stockholders' equity | 980,000 |
| TOTAL LIABILITIES & EQUITY | $ 2,650,000 |
| Computation of net working capital: | ||
| Net working capital | = | Current assets – Current liabilities |
| = | $950,000 – $520,000 | |
| Net working capital | = | $430,000 |
The net working capital computed above resulted in a positive amount. It means that the company has enough current assets to meet its current liabilities. If all current liabilities are to be settled, the company would still have $430,000 left to continue operating.
Generally, a high net working capital is a good sign for the company since it provides some buffer to accommodate additional liabilities while operating. However, excessive current assets may not be so good after all. They could have been invested in more productive assets, e.g., investments, or additional PPE for expansion. In any case, management will have to decide how much is optimal.
Net working capital is a measure of a company's liquidity.
Net working capital is equal to total current assets minus total current liabilities.
A positive amount indicates that the company has adequate current assets to cover short-term obligations.
A high amount indicates that it has available buffer to accommodate additional short-term liabilities. However, a high amount isn't always good, i.e., if it is excessive.
