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)

Change in a Net Working Capital = Change in Current AssetsCurrent Assets Current assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more – Change in Current Liabilities.

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For eg:
Source: Changes in Net Working Capital (wallstreetmojo.com)

How to Calculate Changes in Net Working Capital? (Step by Step)

Find the Current Assets for the current year and previous year.

From the point of the current asset of view, we consider the below:
Inventory
Accounts Receivable
Prepaid Expenses
Find the Current Liability for the Current Year and Previous Year

From the current liabilities, we consider the below:
Accounts PayableAccounts Payable Accounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more & Accrued Expenses
Interest PayableInterest Payable Interest Payable is the amount of expense that has been incurred but not yet paid. It is a liability that appears on the company's balance sheet.read more
Deferred RevenueDeferred Revenue Deferred Revenue, also known as Unearned Income, is the advance payment that a Company receives for goods or services that are to be provided in the future. The examples include subscription services & advance premium received by the Insurance Companies for prepaid Insurance policies etc. read more
Find Working Capital for the Current Year and Previous Year

Working Capital (Current Year) = Current Assets (current year) – Current Liabilities (current year)
Working Capital (Current Year) = Current Assets (current year) – Current Liabilities (current year)
Calculate Changes in Net Working Capital using the formula below –

Changes in Net Working Capital Formula = Working Capital (Current Year) – Working Capital (Previous Year);

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 reducedAccount Receivables Will Get Reduced Accounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet.read more. 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 flowOperating Cash Flow Cash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more, and it is recorded on the statement of cash flowsStatement Of Cash Flows Statement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities.read more. 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 Negative Working Capital Negative Working Capital refers to a scenario when a company has more current liabilities than current assets. It implies that the available short-term assets are not enough to pay off the short-term debts. read more, 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 liabilitiesCurrent Liabilities Current Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc.read more. 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.