What is Net Working Capital (NWC)?
Net Working Capital (NWC) is the net amount of capital that the firm invests in the actual production and sale of its product. It is the gap between a firm's current assets and current liabilities.
It is a measure of a corporation's liquidity. A firm with positive net working capital has enough liquidity to cover its existing payment commitments and engage in other projects.
Understanding Net Working Capital
Net working capital is the amount estimator that indicates the differences between a company's liquidity ratios. It displays on the balance sheet which is used to assess a firm's capacity to satisfy existing short-term commitments also while supporting daily operations.
Cash, receivables, inventories, and other items that are projected to be liquidated or traded in less than a year are described as current assets. Payables, salaries, income taxes, and the existing part of long-term debt due within a year are examples of current liabilities.
Types of Net Working Capital
1. Positive NWC: It implies that an organization is capable of meeting its current financial responsibilities and has finances available to finance, designing and building or expansions, advancement, emergency situations, and so on.
2. Negative NWC: It signifies that your business' financial debt cannot be covered and that it will have to acquire loans or investments to maintain activities and manage stability.
3. Net Zero Working Capital: It shows that your cash flow report is adequate to satisfy its payments but lacks the cash inflows for investments, development, and so on.
The Formula
The formula to calculate NWC is given below -
Net Working Capital = Total Current Assets – Total Current Liabilities
Practical Example
Let's look at a real-world application of the net working capital calculation. The following information of assets and liabilities are available from M&M Corporation is as follow - $40,000 to creditors, $50,000 in debt, $35,000 in inventories, $5000 in salary prepaid and $10,000 in excellent advertisements
To determine M&M Corporation's net working capital, firstly, we must differentiate between current assets and current liabilities. Then we have to add up the current assets and current liabilities before calculating the gap between them.
Debt, inventory and salary prepaid make up the Current Assets while creditors and excellent advertisements sum up the Current Liabilities.
The NWC is –
= Total Current Assets – Total Current Liabilities
= ($50,000 + $35,000 + $5000) – ($40,000 + $10,000)
= $90,000 – $50,000
= $40,000
In Sentences
- The gap between a business's current assets and current liabilities is represented by working capital, often known as net working capital (NWC).
- The net working capital (NWC) of a corporation is an indicator of its liquidity and short-term volume of capital.