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A Guide to Net Working Capital

A Guide to Net Working Capital
Lauren Ward
Lauren WardUpdated September 12, 2022
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Simply put, net working capital is the difference between a company’s current assets (cash and assets that can be converted into cash within a year) and current liabilities (payroll, accounts payable, taxes, and interest owed). Positive working capital indicates that a business can meet its current financial obligations and also invest in other activities and future growth.Business owners will often calculate and track net working capital in order to monitor trends in liquidity from year to year or quarter to quarter. Lenders will also look at net working capital when a business is applying for a small business loan to determine if the firm is financially strong enough to take on additional debt. Read on for a closer look at what net working capital is, how it's calculated, and what it can tell you about your company’s financial position.

What Is Net Working Capital?

Net working capital (NWC) is a measure of a company’s liquidity and short-term financial health. NWC looks specifically at the difference between a company’s current assets and its current liabilities, and provides a window into a company’s short-term financial health — meaning how well it’s been managing its affairs, and how well it will be able to meet its short-term obligations, such as unpaid taxes and short-term debt.Not surprisingly, NWC is often used by lenders to help determine a company’s eligibility for many types of small business loans

Net Working Capital Formula

Learning how to calculate net working capital is relatively easy. The basic formula is: Current Assets - Current Liabilities = Net Working Capital

What Is Included in Net Working Capital

Current Assets: A current asset is anything on a company’s balance sheet that can be converted to cash in less than a year. This can include:
  • Accounts receivable
  • Cash (or a cash equivalent)
  • Commercial paper
  • Inventory
  • Marketable securities (e.g., U.S. Treasury bills, money market funds)
  • Short-term investments a company intends to sell within one year
  • Treasury bills
  • Short-term notes receivable (e.g., short-term loans to customers or suppliers)
  • Prepaid expenses, such as insurance premiums
  • Advance payments on future purchases
If company ABC has $100k in cash, $15k in accounts receivable, and $10k in inventory, then that company would have $125k in current assets. Current Liabilities: A current liability is any financial obligation a company owes that is due within one year. Liabilities typically include:
  • Accounts payable 
  • Interest payable on loans
  • Any loan principal that must be paid within a year
  • Deferred revenue (e.g., advance payments from customers)
  • Rent
  • Taxes payable
  • Utilities
  • Accounts payable
  • Trade credits 
  • Vendor notes
  • Wages
  • Other accrued expenses payable
If a company ABC has $15K in accounts payable, $2K in accrued liabilities, and a $10K due on a small business loan this year, then that company would have $27K in current liabilities. Company ABC’s net working capital would be current assets ($125K) minus current liabilities ($27K), or $98K.

How Does Net Working Capital Work?

A company’s working capital is used to fund operations and meet short-term financial obligations. If a company has sufficient working capital, it means that it will be able to pay its employees and suppliers, pay interest on any loans, pay taxes, and pay other short-term financial obligations, even if it runs into cash flow challenges.Having positive working capital can also mean that a business can fund growth without incurring debt. Or, if they decide to apply for financing, that positive working capital can make it easier for them to qualify for small business loans or other forms of credit with attractive rates and terms.

Calculating Net Working Capital

While the formula for calculating net working capital is simple, you may be unsure about how to account for all of your company’s current assets and liabilities. Fortunately, all the components of working capital can be found in a company's balance sheet, which is a snapshot of the company’s assets, liabilities, and shareholders’ equity at a moment in time (usually at the end of a quarter or fiscal year). Assets are listed by category in order of liquidity (the ease with which they can be converted into cash), starting with cash and cash equivalents, followed by long-term assets (cannot be liquidated in the next year). Liabilities are listed in the same way, starting current liabilities (due within one year and are listed in order of their due date), followed by long-term liabilities (due at any point after one year).

Uses of Net Working Capital

Net working capital is ultimately a tool that can be used by analysts, business owners, and lenders to determine how well a company is performing. While it doesn’t provide a complete picture, NWC is a valuable variable in understanding how solvent a company is, and whether or not that company can take on additional debt. If NWC is significantly positive, for example, it indicates that the business has short-term funds available from its current assets that are more than sufficient to pay for its current liabilities as they come due for payment. If, on the other hand, NWC is significantly negative, the business may not have sufficient funds available to pay for its current liabilities, and could, in fact, be at risk for small business bankruptcyAnother related metric that can be helpful is a company’s working capital turnover, which measures how effectively a business is generating sales for every dollar of working capital put to use.

Net Working Capital vs Working Capital

If you know what working capital is, then you know what net working capital is. The two are one and the same. Both working capital and net working capital refer to the difference between all current assets and all current liabilities.However, some analysts will define net working capital more narrowly than working capital. They might instead use this formula:NWC = Current Assets (Less Cash) - Current Liabilities (Less Debt)

Pros and Cons of Using Net Working Capital

Example of Net Working Capital Calculations

Company XYZ has the following in current assets and current liabilities.Current Assets:Cash: $40,000Inventory:$15,000Accounts Receivable: $10,000Total:$65,000Current Liabilities:Short term debts:$15,000Accounts payable:$10,000Accrued Liabilities: $5,000Total:$30,000Net Working Capital:Current Assets ($65,000)- Current Liabilities ($30,000) = NWC ($35,000)NWC = $35,000

Net Working Capital Schedules

A net working capital schedule is a statement of change in the net working capital of a company. It is often created by an analyst using an Excel sheet, and is calculated in accordance with GAAP (generally accepted accounting principles), using the accrual method of accounting. Accrual accounting is when expenses and sales are recorded at the time of the transaction and not necessarily when the money is received or spent.A NWC schedule Includes sales and cost of goods sold from the income statement for all relevant periods. It also separates current assets and current liabilities into two sections, and creates a final total for net working capital. It may also create another line to calculate the increase or decrease of net working capital in the current period from the previous period.The schedule will typically also include historical data, as well as forecast data, so it can be used to track changes in NWC and forecast future NWC.

Changes in Net Working Capital

Changes in working capital indicate whether a company’s short-term assets are increasing or decreasing in relation to its short-term liabilities. To measure the change, you can use the following formula:(Current Net Working Capital) – (Previous Net Working Capital)It’s generally more useful to compare multiple quarters than it is to compare only the most recent two. This way trends are more easily seen. For example, a new business loan will increase a company’s current liabilities, but if it’s “good” debt, the company will be able to use it to its advantage to increase profits. However, it may take more than one or two quarters to see whether the debt was a good decision or not. Changes in revenue are also to be expected. It can take multiple changes in working capital to determine whether a business is truly on the up and up or going through a downward trajectory. 

Net Working Capital Ratio

Net working capital ratio measures the percentage of a company’s current assets to its short-term liabilities. Like NWC, the NWC ratio can be used to determine whether a firm has sufficient current assets to cover their current liabilities.To calculate your company’s working capital ratio, divide your current assets by your current liabilities:Current Assets ÷ Current Liabilities = Net Working Capital RatioExample: A company has $75k in cash, a $100k in inventory, and $200k in accounts receivable. It has $200k in accounts payable and $100k due this year on a business loan. Therefore:$375k ÷ $300k = 1.25Ideally, a company’s net working capital ratio should be around 2. Anything less than 1 suggests the company may have liquidity issues in the near future. 

The Takeaway

Net working capital is the difference between a company’s current assets and its current liabilities. Positive working capital indicates that a company can pay its bills and invest to spur business growth.As a small business owner, it can be important to calculate and manage working capital. This helps ensure that your company can meet its day-to-day operating expenses while using its financial resources in the most productive and efficient way. Knowing your NWC is also important if you are interested in getting a small business loan. Lenders like to see a strong NWC because it suggests that a company can take on additional debt and keep up with payments. However, NWC is usually one of many factors a lender looks at when determining loan eligibility. 

Small Business Loan Tips

  1. Generally, it can be easier for entrepreneurs starting out to qualify for a loan from an online lender than from a traditional lender. Lantern by SoFi’s single application makes it easy to find and compare small business loan offers from multiple lenders.
  2. If you are launching a new business or your business is young, lenders will consider your personal credit score. Eventually, though, you’ll want to establish your business credit.
  3. 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.

Photo credit: iStock/yongyuan
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Frequently Asked Questions

How is net working capital calculated?
What is net working capital on a balance sheet?
How are working capital and net working capital different?

About the Author

Lauren Ward

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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