Net Working Capital Definition

In simple terms, net working capital (NWC) denotes the short terms liquidity of a company and is calculated as the difference between the total current assets and the total current liabilities

Net Working Capital Formula

Let’s have a look at the formula –

There are two important elements.

The first element is the current assets. Current assets are those assets that can be liquidated within one year or less. That means current assets will pay you off for less than a year. We can give examples of current assets as sundry debtors, accounts receivables, inventories, prepaid salaries, etc.
The second element is the current liabilities. Current liabilities are those liabilities that can be paid off for less than a year. The examples of current liabilities are sundry creditors, accounts payables, outstanding rent, etc.

Example

Let’s take a practical example of networking capital formula.

Tully Company has the following information –

Sundry Creditors – $45,000
Sundry Debtors – $55,000
Inventories – $40,000
Prepaid salaries – $15,000
Outstanding advertisements – $5000

Find out the NWC of Tully Company.

In the above example, we have been given both current assets and current liabilities.

First, we need to separate the current assets from the current liabilities.

Then we need to total the current assets and also the current liabilities. And then, we need to find the difference between the current assets and the current liabilities.

Current Assets – Sundry Debtors, Inventories, Prepaid salaries;
Current Liabilities – Sundry Creditors, Outstanding advertisements.

Total current assets = (Sundry Debtors + Inventories + Prepaid salaries) = ($55,000 + $40,000 – $15,000) = $110,000.

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Total current liabilities = (Sundry Creditors + Outstanding advertisements) = ($45,000 + $5000) = $50,000.

The Net Working Capital Formula is –

Total Current Assets – Total Current Liabilities = $110,000 – $50,000 = $60,000.

Colgate Example

Below is the Balance Sheet Snapshot of Colgate’s 2016 and 2015 financials.

Let us do the Calculation for Colgate

NWC (2016)

Current Assets (2016) = 4,338
Current Liabilities (2016) = 3,305
NWC (2016) = 4,338 – 3,305 = $ 1,033 million

NWC (2015)

Current Assets (2015) = 4,384
Current Liabilities (2015) = 3,534
NWC (2015) = 4,384 – 3,534 = $850 million

Use of Net Working Capital

If you look at current assets and current liabilities, you will find them on the balance sheet. Investors use NWC to know whether a company is liquid enough to pay off its short-term liabilities. That’s why NWC needs to be interpreted properly.

There are two ways through which we can interpret NWC.

When the NWC is positive, the investors can understand that the company has enough current assets to pay off its current liabilities.
And when the NWC is negative, the investors can comprehend that the company doesn’t have enough assets to pay off its current liabilities.

Investors can also see the usefulness of NWC in calculating the free cash flow to firm and free cash flow to equity. But if there is an increase in the NWC, it isn’t considered as positive; rather, it’s called negative cash flow. And obviously, this increased working capital is not available for equity.

Net Working Capital Calculator

You can use the following calculator

Total Current Assets
Total Current Liabilities
Net Working Capital Formula

Net Working Capital Formula =	Total Current Assets – Total Current Liabilities
0 – 0 =	0

Net Working Capital Formula in Excel (with excel template)

Let us now do the same example above in Excel. This is very simple. You need to provide the two inputs of Total Current Assets and Total Current Liabilities.

You can easily do the Calculation in the template provided.