Net Operating Working Capital (NOWC), Explained

Lauren WardUpdated June 9, 2023

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Net operating working capital (NOWC) is one measurement of a company’s financial health. It looks at how efficiently a company is managing its current assets and liabilities. Unlike plain net working capital, net operating working capital excludes cash and cash equivalents, since they are not tied up in operations. This makes net operating working capital more closely tied to current cash flows, and a more accurate indicator of a company’s ability to sustain cash flow in the face of changes or obstacles.Read on to learn how to calculate net operating working capital, why it's important, how it differs from other measures of working capital, and see an example of a NOWC calculation.

What Is Net Operating Working Capital?

To understand what net operating working capital is, it’s helpful to know what working capital is. Working capital is the money available to meet your current, short-term obligations. It’s calculated by subtracting current liabilities from current assets, as listed on the company’s balance sheet. Current assets are those that can be converted into cash within one year; current liabilities are obligations expected to be paid within one year.Net operating working capital measures the difference between a firm's current assets, such as inventory and accounts receivable, and its current liabilities, such as accounts payable and accrued expenses. Unlike net working capital, however, it excludes cash and cash equivalents, such as bank deposits and short-term investments, since they are not tied up in operations and can be converted into cash if needed.NOWC also excludes debt (such as different types of small business loans) and interest-bearing securities, since these items represent a method of raising the necessary capital to fund ongoing operations.

Net Operating Working Capital Formula

Here’s a look at the net operating working formula:Net Operating Working Capital (NOWC) = Operating Current Assets - Operating Current LiabilitiesOperating current assets includes:

Accounts receivable
Accounts payable
Inventory

Operating current liabilities includes:

Accrued expenses
Prepaid expenses
Deferred revenue

Calculating Net Operating Working Capital

To calculate net operating working capital, you need to:

Determine your company's current assets. These are assets that are expected to be converted into cash within one year. Examples include: accounts receivable, inventory, and prepaid expenses. You can find your company's current assets listed on its balance sheet.
Determine your company's current liabilities. These are debts that are expected to be paid within one year. Examples include: accounts payable, accrued expenses, and short-term loans. You can find a company's current liabilities listed on its balance sheet.
Exclude cash and cash equivalents. Cash and cash equivalents are excluded from the NOWC formula because they are not tied up in a company's day-to-day operations. These include: bank deposits and short-term investments.
Calculate net operating working capital. Now, you simply subtract your company's current liabilities (excluding any short-term debt that has been used to finance current assets) from its current assets (excluding cash and cash equivalents).

What Is Net Operating Working Capital Used For?

Calculating NOWC provides a measure of your company's liquidity — or, in other words, its ability to meet its short-term financial obligations. Having a high NOWC, for example, makes it easier to pay your bills as they come due. It also allows you to invest in growth opportunities when they come up and increase profits. If, on the other hand, a business has too little NOWC, it risks not having sufficient funds to pay off outstanding liabilities and may not be able to remain solvent. It will also lack funds to invest in future growth.Once you have calculated NOWC, you can use it to analyze your firm's financial health and compare it to industry benchmarks or its historical performance.

Working Capital vs Net Operating Working Capital

	Working Capital	Net Operating Working Capital
What it measures	Looks at all current assets and current liabilities	Only looks at current assets and liabilities related to daily operations
Focus	Broader	Narrower
Cash and short-term debt included?	Yes	No
Uses	Look at a firm’s overall profitability	Helps determine if a company can remain solvent

Net operating working capital (NOWC) and net working capital (NWC) are both financial metrics that can be used to evaluate a company's liquidity and overall financial health. NWC, however, includes all of a company's current assets and liabilities, including cash and cash equivalents. It is calculated by subtracting a company's current liabilities from its current assets.NOWC, by contrast, is a narrower measure that excludes cash and cash equivalents from current assets, and short-term debt that has been used to finance current assets from current liabilities.It is calculated by subtracting a company's current liabilities (excluding any short-term debt used to finance current assets) from its current assets (excluding cash and cash equivalents).As a result, NOWC tends to be a more precise measure of a company's ability to fund its day-to-day operations. It hones in on the capital a company has tied up in its day-to-day operations, which is more relevant for short-term financial management.Recommended: Working Capital Management Explained

Net Operating Working Capital Example

Here is an example of how to calculate NOWC for fictional company ABC.ABC’s operating current assets are:Accounts Receivable = $5 millionInventory = $30 millionPrepaid Expenses = $4 million Total operating current assets = 39 millionABC’s operating current liabilities are:Accounts payable = $10 millionAccrued expenses = $7 millionDeferred revenue = $3 million Total operating current liabilities = 20 millionWe then plug theses numbers it to the NOWC formula:Net Operating Working Capital (NOWC) = Operating Current Assets - Operating Current LiabilitiesNOWC = 39 million - 20 million NOWC = 19 millionBased on the operating working capital formula, ABC has a positive NOWC, which means it is capable of paying off all of its current operating liabilities with some assets left over. This indicates that things are going well — ABC could meet its obligations all at once if needed and still have funds left to cover their current operations.

The Takeaway

Net operating working capital measures a company’s short-term liquidity, meaning its ability to meet short-term financial obligations. If a company has a positive NOWC, it is able to cover all of its liabilities. If it doesn’t, something is not operating as well as it could. Some ways to improve your company’s NOWC include: reducing inventory levels, improving collections from customers, negotiating better payment terms with your suppliers, and improving operational efficiency. You might also consider financing options, such as a working capital loan, which can provide short-term financing to cover operating expenses or factoring, where you sell its accounts receivable to a third-party for cash.

3 Small Business Loan Tips

Online lenders generally offer fast application reviews and quick access to cash. Conveniently, you can find recommended small business loans by using Lantern by SoFi.
Traditionally, lenders like to see a business that’s at least two years old when considering a small business loan.
If you need to borrow money to cover seasonal cash flow fluctuations, a business line of credit, rather than a term loan, provides the flexibility you likely need.

Let Lantern help you find the right financing solution for your small business.

Frequently Asked Questions

How are operating capital and operating working capital different?

What does net operating working capital include?

What is net operating working capital an indicator of?

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About the Author

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.

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