What are Changes in Net Working Capital?
Change in the net working capital is the change in net working capital of the company from the one accounting period when compared with the other accounting period which is calculated to make sure that the sufficient working capital is maintained by the company in every accounting period so that there should not be any shortage of funds or the funds should not lie idle in future.
Formula
Changes in Net Working Capital = Working Capital (Current Year) – Working Capital (Previous Year)
Or
Change in a Net Working Capital = Change in Current Assets – Change in Current Liabilities.
How to Calculate Changes in Net Working Capital? (Step by Step)
- Step 1 – Find the Current Assets for the current year and previous year
From the point of the current asset of view, we consider the below:
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- Inventory
- Accounts Receivable
- Prepaid Expenses
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- Step 2 – Find the Current Liability for the Current Year and Previous Year
From the current liabilities, we consider the below:
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- Accounts Payable & Accrued Expenses
- Interest Payable
- Deferred Revenue
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- Step 3 – Find Working Capital for the Current Year and Previous Year
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- Working Capital (Current Year) = Current Assets (current year) – Current Liabilities (current year)
- Working Capital (Current Year) = Current Assets (current year) – Current Liabilities (current year)
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- Step 4 – Calculate Changes in Net Working Capital using the formula below –
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- Changes in Net Working Capital Formula = Working Capital (Current Year) – Working Capital (Previous Year).
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Change in Net Working Capital Calculation (Colgate)
Below is the Snapshot of Colgate’s 2016 and 2015 balance sheet.
Let us calculate the Working Capital for Colgate
Working Capital (2016)
- Current Assets (2016) = 4,338
- Current Liabilities (2016) = 3,305
- Working Capital (2016) = 4,338 – 3,305 = $ 1,033 million
Working Capital (2015)
- Current Assets (2015) = 4,384
- Current Liabilities (2015) = 3,534
- Working Capital (2015) = 4,384 – 3,534 = $850 million
Net change in Working Capital = 1033 – 850 = $183 million (cash outflow)
Analysis of the Changes in Net Working Capital
Change in Working capital does mean actual change in value year over year i.e. it means the change in current assets minus the change in current liabilities. With the change in value, we will be able to understand why the working capital has increased or decreased.
Below are a number of actions that will cause a change in Net Working capital:
- If the company does not allow outstanding credit, the account receivables will get reduced. But sales may have a declining effect.
- Inventory planning also impacts the change in working capital. An increase in inventory increases the usage of cash.
- Stretching accounts payable impacts the change in working capital.
- If the growth rate of the company is high, it uses the cash more for buying inventories and increasing account receivables. Cash will be heavily used for it then.
It is an indicator of operating cash flow and it is recorded on the statement of cash flows. And the cash-flow is one of the important factors to be considered when we value a company. It indicates whether the short-term assets are increasing or decreasing with respect to the short-term liabilities from one year to the next.
Conclusion
If the Net Working capital is increasing, we can conclude that the company’s liquidity is increasing. It could indicate that the company is able to utilize its existing resources in a better way. Some companies have negative working capital and some companies have positive as we have seen in the above two examples of Microsoft and Walmart. Generally, companies like Walmart which have to maintain a large amount of inventory have negative working capital.
The software companies generally tend to have positive working capital because they do not have to maintain an inventory before they can sell the product. It means that it can generate revenue without increasing current liabilities. Cash flow cannot increase or decrease with an only change in working capital. But if it is not sufficient, the company’s efficiency is greatly reduced.
- If the current assets and current liabilities have increased by the same amount, there would be no change in net working capital.
- If the change is positive, then the change in current liabilities has increased more than the current assets.
- If the change is negative, it means that the change in the current assets has increased more than the current liabilities.
Changes in Net Working Capital Video
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