Net working capital for a business stands for the difference between the value of its short-term assets and liabilities. It is one of the most crucial business figures as it offers a realistic overview of the financial health of an organization.
A healthy net working capital figure shows that the organization manages its finance and resources most effectively. One can calculate this figure in several ways. It depends on the probable objective that one is analyzing. Paragraphs underneath shall throw light on the significant aspects in this regard.
Your guide to computing the Net Working Capital of a business
You are wondering what working capital is? To compute the net working capital for a business, one needs to consider the total values for its Short-term assets and liabilities. Alternatively, you may select some other aspects, depending on the figure you need to analyze and the probable outcome you aspire to find. Most importantly, it would help if you had a clear perception of the aspects that make your business’s assets and liabilities. The calculation majorly depends on the classification between short-term and long-term assets and liabilities for your organization. Once you get a specific idea about these parameters, calculating the net working capital is not a big deal.
Short-term Assets, alternatively known as current assets, include all those resources that a business can liquidate within the minimum time. Usually, it constitutes all those assets that a business plans to monetize by the next couple of years. Typically, short term assets include the following resources:
- Cash and its equivalents
- Accounts and Notes Receivables
- Inventory inclusive of stock in trade
- Short-span investments
- Liquefiable Securities
- Expenses paid in advance
Resources like Properties and long-term investments, Trademarks, Copyrights, and Franchises are never accounted as short-term assets. For this reason, these resources are approached with a long-term perspective, and an organization will never liquidate these resources within a short span.
Short-Term Liabilities: these are the obligations for a business that it needs to pay within a short time. It usually includes:
- Rent and Utilities Payable
- Accounts Payable within a short time
- Interest Payable
- Taxes and duties payable immediately
In this regard, please note that the following liabilities should never count as short-term liabilities:
- Deferred Taxes
- Obligations towards retirement and pension payment
- Deferred Revenues
- Bonds Payable
The figures constituted in these regards comprise the long-term liabilities for an organization.
Net Working Capital Formula
Once you have segregated the long and short-term assets and liabilities, you can apply formulas for computing the net working capital for your business. Usually, organizations apply either of the following approaches to derive the desired figure:
- Short Term Assets – Short Term Liabilities= net working capital: it offers a general approach to net working capital as you deduct the value of your short-term liabilities from the Short Term asset value. This calculation derives the financial value for the cash flow or the operating asset for the business. Please note that this formula will never evaluate the total asset value for the business.
- Another formula for computing the net working capital includes similar facts and figures, except the cash component involved as assets or liabilities.
The points discussed above give a clear guide to the computation for the net working capital requirement for a business at any time. The trick is to control the short-term liabilities and optimize the short-term assets to enable the business to operate with the minimum working capital needs.
Thus, a business should always work in keeping the right balance between these aspects to retain its fiscal health.