Net Working Capital Formula and Definition

Net working capital (NWC) is the difference (or ratio) between your company’s current assets and current liabilities, determining your liquidity. Your net working capital measures the short-term financial health of your organization.

Ideally, you want a positive net working capital ratio, meaning higher total current assets than total current liabilities. A negative net working capital ratio means your company has more liabilities than assets and is less likely to meet short-term obligations, such as paying utility bills or staff wages.

The formula to calculate net working capital is:

Current Assets - Current Liabilities = Net Working Capital

For example, if you have $150,000 in current assets and $45,000 in current liabilities, your net working capital or short-term liquidity is $105,000.

Before applying the net working capital formula and calculating your company’s current ratio, you’ll need to determine two values: your current assets and your current liabilities. “Current” in the financial world means within the next year, so the numbers you calculate only have to be for the upcoming twelve months. You can find your current assets and current liabilities by examining your company’s balance sheet or financial statements.

Your current assets consist of all financial gains expected in the next twelve months, including:

• Accounts receivable: Money owed to your company for items or services sold or money expected for any other agreements is known as accounts receivable.
• Cash and cash equivalents: Cash includes your company’s free cash flow, short-term assets such as cash on hand, and low-risk, short-term investments such as money market accounts.
• Current inventory: Inventory refers to unsold goods, including raw materials used in manufacturing, or any other items in process or ready to be sold.
• Prepaid expenses: Though prepaid bills do not equal liquid assets, include them as they have value in the short term.

Your current liabilities consist of all financial debts your company owes or will owe in the next twelve months, including:

• Accounts payable: All money your company currently owes to an outside vendor or organization is accounts payable. This includes rent, utilities, income tax, property tax, credit card bills, vendor invoices, utilities, or any other expense required for operating.
• Current portion of long-term debt: You may be paying off a long-term debt to lenders (such as a multiyear loan), so include only the short-term payments you’ll owe for the next twelve months.
• Dividends payable: If you have shareholders expecting dividend payments, include the amounts authorized.
• Employee wages: All salaries and wages owed to employees and staff through payroll. If you pay your employees monthly, consider this a short-term liability.
• Unearned revenue: Any prepaid amounts you’ve received from clients for work or goods you haven’t delivered is unearned revenue.

Your company’s net working capital provides essential financial modeling information about your business and its valuation. When your company has a positive net working capital ratio, it means you have the cash flow to spend on your short-term debts. Your net working capital affects your company’s ability to pay your rent, staff, and utility bills.

If you have a small business, you might use your working capital to grow your company’s business operations without having to incur debt. If you need extra cash, lenders are more likely to extend a line of credit or a short-term loan to a company with positive net working capital.

On the other hand, if your company has a negative working capital metric or more accrued expenses than assets, you don’t have enough liquidity to pay your short-term financial obligations such as utility bills, wages, or vendors.

If you want to improve your financial ratios, you can add to your current assets or reduce your current liabilities. To do this, consider:

• Improving inventory management: Buy only what you need to operate to reduce overstocking and slow inventory turnover.
• Increasing long-term debt: Taking out a loan that isn’t due immediately means increasing your current cash flow without increasing your current liabilities.
• Limiting credit extensions: Ask customers to pay cash instead of credit to increase current assets.
• Reducing expenses: Examine what you can stand to lose. It might mean reducing staff or switching to a cheaper vendor, thus reducing your current liabilities.
• Refinancing: Refinancing short-term debt as long-term debt makes your repayment due date outside the upcoming twelve-month period.
• Selling assets: Increase your current assets by selling off what you don’t need.

MasterClass at Work is the learning platform to help unlock the full potential of your employees and inspire a learning lifestyle in everyone. From negotiation to mindfulness to baking—these are just a few things your teams can explore.