This net working capital calculator estimates the net working capital value/ratio by considering the short term liabilities and the current assets of a company in order to assess its short-term liquidity. There is in depth information about the formulas used below the tool.
How does this net working capital calculator work?
The figure of the net working capital (NWC) is used to assess the short-term liquidity of a company or to evaluate how efficient an entity is using its own assets.
The algorithm behind this net working calculator uses two different equations as explained within the 2 tabs it offers:
Within the 1st tab named “Method 1” you can determine the absolute value of the net working capital by this formula:
NWC = Cash & cash equivalents + Inventory + Marketable investments + Trade accounts receivable - Trade accounts payable.
Within the 2nd tab named “Method 2” you can calculate the net working ratio by applying this equation:
NCW = Current Assets – Current Liabilities
In the specialty literature the net working capital is known as the working capital. There is also an alternative way to determine a ratio by comparing the net working capital value against the total assets value:
Net working capital ratio = (Current Assets – Current Liabilities)/Total Assets.
The interpretation of the net working capital level
Any positive value of the net working capital demonstrates that the company being analyzed has available sufficient short-term resources from its current assets to pay for its current obligations due in less than 12 months. However a substantially positive figure may indicate that the company in question does not have a proper management of its resources because it may be a signal that it keeps blocked more resources than required to pay off its current liabilities.
On the other side, in case the net working capital value is negative (or even worse substantially negative) this situation is interpreted as a negative signal that the company may not have sufficient internal resources to repay its short term debts, thus it is considered a signal of insolvency.
Apart from evaluating whether a business is sufficient short term liquid or not, the net working capital can also be used to determine whether a specific company has good future prospects of growing quickly its business. An extremely short-term liquid position may be a signal that the cash reserves the company owns can be used to develop its business which is an important criterion an investor takes account of.
On the other hand if the NWC equals zero or if it is negative that indicates it is improbable for the business to develop rapidly.
The interpretation of the net working capital level should be made by taking account of multiple financial aspects such as:
- the structure of the current assets and how liquid are they. If the NWC is substantially positive but the current assets cannot be easily converted into cash then they may not be available for paying the short term debts;
- are there any short term payments that may occur apart from those already registered and which is the likelihood that the company will be requested to pay them off;
- Is there any line of credit the business can use to payoff its existing short term liabilities.
In case of a negative net working capital vale there are few important steps that may be taken:
Negotiate with both the existing and new customers to pay you in a shorter time period than before.
Negotiate with suppliers in such a way to allow you pay the bills and invoices in a longer time frame than before.
Set up a correct approach on collecting outstanding accounts receivable.
Try to run the business by working by just-in-time inventory in such a way to reduce the costs with inventory or the level of the investment required.
Example of a NWC calculation
Let’s illustrate an example of a company that has $50,000 cash, $100,000 accounts receivable and $250,000 in inventory. Its short terms obligations include accounts payable of $150,000 and a short term loan of $100,000. Applying the standard NWC formula would result a positive balance of $150,000:
NWC = $50,000 + $200,000 + $150,000 - $150,000 - $100,000 = $150,000.
However, a significant part of its current assets consist of inventories and they are usually considered less liquid, thus this situation may be interpreted as a negative signal that the company may not succeed to quickly convert its inventory into cash in order to pay off its debts.11 May, 2015 | 0 comments