Your net working capital (NWC) describes the funds available to your business. It is the combination of all assets and payments your business has collected minus any owed debts or liabilities. Understanding this calculation is important because it helps you better grasp the performance of your business and the assets you have available to grow your organization.
There are a few net working capital formulas you can use depending on your goal with the final figure.
- Total current assets - total current liabilities
- Total current assets (without cash) - total current liabilities (without debts)
- Total inventory + accounts receivable - accounts payable
Each calculation will provide you with slightly different pictures of your business's working capital. Brands might use the calculation of their working capital to track the impact of changes to business factors, such as their inventory or accounts receivable.
Many organizations also see the importance of calculating the net working capital ratio. This ratio also provides a helpful metric to look at the financial health of your business. It's calculated by dividing the total current assets by the total current liabilities. Determining how a current ratio for your company compares to others in the industry can help you with working capital management and gauge your spending and revenue.
To help businesses manage their accounting processes, Skynova offers accounting software that makes it easy to track the flow of money. Particularly for small businesses that might not have a separate accounting team, this software simplifies the process of tracking finances and understanding the full financial standing of your company.
To effectively run your business, you need to understand the value of the net working capital calculation and how it impacts your company's ability to grow and plan. Let's explore the scope of this accounting figure.
Understanding Networking Capital's Importance
As a business owner, you want to make sure you know your net working capital because that number tells you whether you have the money to meet your current financial obligations. It will also tell you if you have enough funds to invest in business growth.
For example, if you calculate your net working capital and find that you have working capital of $50,000, you may be able to use some of that money to invest in a new software program or hire an independent contractor to help manage tasks. On the other hand, if you learn that you have a negative working capital, you know you don't have enough to cover your obligations. You might need to consider a business loan or other business practices to get your company back in shape.
To calculate your net working capital, you'll need to include a few important line items from your balance sheet.
What Does Net Working Capital Include?
Since a calculation of your net working capital tells you the liquidity of your company, you need to subtract your current liabilities from your current assets. Bring your balance sheets and other accounting information together to run this equation.
Your company's current assets consist of everything that your company owns that could potentially be liquidated within a year, particularly short-term liquidity. Your inventory can be sold, your accounts receivable can be paid, and you can access any investments or cash equivalents you made with your business. For example, some people have business money market accounts. Finally, consider any cash that you have for your organization.
You will want to add these sources together to determine your current assets. This will be the first part of the equation.
Next, add together the different liabilities you have. Your liabilities are everything that you will have to pay within the next year. Gather your business's financial statements to better understand your liabilities. Common sources of liability include:
- Business or real estate loan payments
- Accounts payable
- Business credit cards
All of this information will comprise your current liabilities. Since you owe this money to people outside your business, you don't want to include this money when considering the amount of revenue you have to run your business.
How Do You Calculate Net Working Capital?
Now that you have your current assets and your current liabilities, you have the information you need to do your calculation. To find your net working capital, you will want to run the following equation:
Net Working Capital = Current Assets – Current Liabilities
Subtract your current total liabilities from your current total assets so you can see how much money you have left to invest in your business.
Net Working Capital Examples
It can help to review examples to better understand how to calculate net working capital. Here are a few sample businesses to review.
A local craft store has the following assets:
- $10,000 in inventory
- $2,000 in cash
- $6,000 in investment accounts
The craft store also has the following liabilities:
- $6,000 to be paid on a real estate loan
- $1,000 in vendor fees
- $2,000 to be paid on a business credit card
This store would calculate its net working capital as:
($10,000 + $2,000 + $6,000) - ($6,000 + $1,000 + $2,000)
$18,000 - $9,000
$9,000 = Net working capital
This tells the store owner that they are doing well financially. They might decide to invest in some additional help once a week or perhaps open an online store to expand their selling opportunities.
Another example might be found with a local marketing company. They might encounter finances like:
- $6,000 in accounts receivable
- $4,000 in cash
- $2,000 in investment accounts
- $3,000 in accounts payable for contractors
- $2,000 in a business loan
- $4,000 in vendor notes
This particular business would run their net working capital equation as:
($6,000 + $4,000 + $2,000) - ($3,000 + $2,000 + $4,000)
$12,000 - $9,000
$3,000 = Net working capital
This small marketing company finds they have positive net working capital but not as much as the craft store. They might want to think about ways to improve their net working capital to build themselves more usable capital to power their growth.
How Do You Improve Your Net Working Capital?
Here are a few strategies business owners can use to improve their cash flow:
- Shorten the billing cycle and ensure that your customers pay more frequently for goods or services. Allowing a long billing cycle means you might provide a good or service and then not see payment for an extended period of time, which then impacts the capital on hand to invest in your business.
- Be sure to follow up with customers regularly regarding payments. Once a payment becomes due, let the customer know you're waiting for remittance to help cut down on receiving late payments and ensure that your accounts are paid on time.
- Return unused inventory to the vendor so you can get a refund on what was not sold. This can also help you maintain better accounts.
- Lengthen the amount of time you have to pay your vendors and negotiate your payment terms. If you can negotiate longer times to pay without incurring late fees, it can also help you increase your working capital temporarily while you fill your business needs and spur growth.
- Transition debts from short-term debt and other short-term obligations into long-term debt. This will also help to lower payments due at a given time, which can increase capital.
- Bring in more capital. You can also increase your working capital by bringing in more revenue through increased sales. Review your marketing and sales strategy and find room for improvement.
Let Skynova Help You With Your Small Business Accounting
Understanding the value of a net working capital calculation can help organizations of all sizes accurately track their assets and promote business success. It's a core part of corporate finance and helps businesses gauge their current obligations, long-term assets, and short-term assets.
If you're interested in improving your accounting process, Skynova offers accounting software that can help small businesses keep track of their cash flow. We also have other software products and templates to help with a host of business needs, including creating invoices and managing retainers. See what these offerings can do for your business.