Net Working Capital Ratio Calculator

How does this net working capital ratio calculator work?

As the term itself suggests the net working capital ratio refers to the net amount of all resources considered working capital and can be used to understand whether an entity has sufficient internal net resources to run its business on short term.

This net working capital ratio calculator allows you determine this financial indicator by 2 different approaches as described here:

• By 1^st tab (Method 1) you can estimate the net working capital by subtracting the current liabilities figure from the one of the current assets, resulting an absolute value which can be either positive, negative or zero.

NWC as absolute value = Current assets - Current liabilities

• By 2^nd tab (Method 2) you can caclulate the NWC by an alternative equation that requires measuring the proportion of the net working capital absolute figure against the total amount of assets from the balance sheet.

NWC as ratio = (Current assets - Current liabilities)/Total Assets = NWC as absolute value/Total Assets

Independent on the formula used to determine it, this liquidity ratio has few limitations such as:

- It does not take account of the time required to convert the current assets into cash, neither of the term in which the current liabilities become due, thus for an appropriate analysis on the liquidity position of a company these aspects should also be considered.

- Any short term line of credit a company may have available to finance its activity if that would be the case is not taken into account, thus in case of a negative NWC that does not necessarily mean the business may face default.

The interpretation of the net working capital ratio level

• Generally speaking when referring to the NWC calculated as an absolute value (see first formula provided above) the higher the value is the better as this indicates that the company has sufficient current assets to finance its business on a short run and so it is interpreted as a positive signal that there is no risk of facing default.

Any negative value suggests that the company may have difficulties in paying its short term obligations, while any NWC equal to zero indicates that the value of the current assets equal the amount of the current liabilities.

However, please note that since not all the current assets can be easily and quickly converted into cash a net working capital value equal to zero does not necessarily mean that the company will be able to meet its short term payments.

On the other side a too high absolute value may suggest that the company is not using efficiently its internal resources for generating new revenue and profits or for developing its business.

• In case of a NWC ratio calculated as a proportion (see second equation explained above) the higher than 0 the ratio is the better as it basically demonstrates that the current assets exceed the volume of the current liabilities and that the business is keeping its resources in liquid assets rather than in fixed ones.

Examples of NWC ratio calculations

Scenario 1:

A company has current assets of $100,000 and current liabilities of $90,000, then its NWC would be $100,000 - $90,000 = $10,000. Since it is a positive value this may suggest that the company has sufficient net funds to pay off its short term debts.

Scenario 2:

Let’s consider another company with current assets of $500,000, current liabilities of $400,000 and total assets of $800,000. In this case the NWC ratio would be ($500,000 - $400,000)/ $800,000 = $100,000/$800,000 = 0.125 (or 12.5%). This figure may suggest that the company is sufficient liquid to meet its short term obligations.