How to Find Change in Net Working Capital

Net Working Capital (NWC) offers a quick view into a company’s short-term financial health and its operational efficiency. It provides an indication of the funds a business has available to manage its daily activities and obligations. Understanding NWC helps assess a company’s ability to meet its immediate financial commitments. This metric does not delve into long-term financial strategies but focuses purely on short-term liquidity.

Identifying the Components of Net Working Capital

Net working capital is found by subtracting current liabilities from current assets. This calculation provides insight into a company’s ability to meet its short-term obligations and fund ongoing operations. Both current assets and current liabilities are financial categories found on a company’s balance sheet, which is a financial statement presenting a snapshot of a company’s assets, liabilities, and equity at a specific point in time.

Current assets include resources a company expects to convert into cash, use up, or sell within one year or its operating cycle, whichever is longer. Common examples of current assets are cash and cash equivalents, which include money held in bank accounts and highly liquid investments like Treasury bills. Accounts receivable, representing money owed to the company by its customers for goods or services already provided, also fall under current assets, provided they are expected to be collected within a year. Inventory, comprising raw materials, work-in-progress, and finished goods held for sale, is another significant current asset. Additionally, prepaid expenses, which are payments made for goods or services to be received in the future, are categorized as current assets.

Current liabilities are a company’s short-term financial obligations that are typically due within one year. These obligations are usually paid from the revenue generated by the company’s operating activities. Examples of current liabilities include accounts payable, which is money owed by the company to its suppliers for goods or services purchased on credit. Short-term debt, such as lines of credit or loans due within a year, also constitutes a current liability. Accrued expenses (like salaries, wages, utilities, and taxes that have been incurred but not yet paid) and the current portion of long-term debt (the principal amount of long-term debt due within the next 12 months) are also common current liabilities.

Calculating Net Working Capital for a Period

Calculating net working capital for a specific period involves a straightforward formula: Current Assets minus Current Liabilities. This calculation provides a single dollar figure representing the amount of capital available for short-term operations. This figure is derived directly from the current assets and current liabilities reported on a company’s balance sheet for that particular period.

To illustrate, consider a hypothetical example for a company at the end of a fiscal year. Suppose the company’s balance sheet shows total current assets of $150,000. These assets might include $30,000 in cash, $50,000 in accounts receivable, and $70,000 in inventory. For the same period, assume the company has total current liabilities of $70,000, which could consist of $40,000 in accounts payable and $30,000 in short-term debt. Applying the formula, the net working capital for this period would be calculated as: $150,000 (Current Assets) – $70,000 (Current Liabilities) = $80,000.

Determining the Change Over Time

To determine the change in net working capital, you need to compare the net working capital figures from two different reporting periods. This comparison reveals how a company’s short-term liquidity and operational efficiency have evolved. The formula for calculating the change in net working capital is: Net Working Capital (Later Period) – Net Working Capital (Earlier Period).

For instance, imagine a company’s net working capital at the end of Year 1 was $80,000. Then, at the end of Year 2, the company’s current assets totaled $170,000 and its current liabilities were $85,000. The net working capital for Year 2 would be $170,000 – $85,000 = $85,000. Using the formula, the change in net working capital from Year 1 to Year 2 would be $85,000 (Year 2 NWC) – $80,000 (Year 1 NWC) = $5,000. A positive result, like this $5,000, indicates an increase in net working capital over the period, while a negative result would signify a decrease.