Definition of Net Working Capital
Net working capital is the amount (as opposed to being a ratio) remaining after subtracting a company’s total amount of current liabilities from its total amount of current assets. Hence, the formula is: net working capital = current assets minus current liabilities. (Net working capital is also known as working capital.)
Example of Net Working Capital
As an example, a company with current assets of $130,000 and current liabilities of $100,000 has $30,000 of net working capital. This amount may be sufficient for some companies but inadequate for other companies.
Difference Between Net Working Capital and Liquidity
Net working capital is often cited as one of the indicators of a company’s liquidity. However, the amount of net working capital alone does not assure a company of the liquidity necessary to pay its current liabilities when they come due. For example, if a company’s current assets consist mainly of slow-moving inventory and some slow-paying accounts receivable, the company may not be able to convert its current assets to a sufficient amount of cash in time to pay its obligations. Not having sufficient cash to pay employees, suppliers and other creditors may lead to serious problems.
In contrast, another company that sells fast-moving products online with customers paying with credit cards will have liquidity even with a small amount of net working capital. If this company’s suppliers also have credit terms of net 60 days or the company pays its bills by using its business credit card, the company may be able to operate with negative working capital.
Managing Working Capital
In short, net working capital management is critical for a company’s positive relationships with lenders, suppliers, employees and customers. All of the components of net working capital should be examined in detail and managed properly.
