Working capital, also referred to as net working capital, is the difference between a company’s current assets (such as accounts receivable, cash, and inventories of raw materials and finished goods) and its current liabilities (such as accounts payable and debts).
Net working capital is a measure of a company’s liquidity, short term financial health and operational efficiency. If a company has substantial positive net working capital, it should have the potential to invest and grow. However, if a company’s current assets don’t exceed its liabilities then it will have trouble paying back creditors and growing further.
Why is net working capital important?
Net working capital is necessary for businesses to remain solvent. In theory, a business could become bankrupt even if it is profitable. After all, a business cannot rely on paper profits to pay bills; bills need to be paid in cash readily in hand.
How to calculate net working capital
It should be calculated on a consistent basis, so that the results generated can be tracked on a trend line. To calculate your net working capital, follow this formula:
Marketable investments + Cash and cash equivalents + Trade accounts receivable + Inventory – Trade accounts payable = Net working capital