What is net working capital? How to calculate it with the right formula? Why is it important? If you're looking for answers to these questions, you've come to the right place. In this article, you will learn everything you need to know about Net Working Capital. Furthermore, you will have access to an excel template that lets you calculate the Net Working Capital for more than 65,000 companies with just one click.
What is Net Working Capital?
By definition, Net Working Capital (NWC) is a financial metric that represents the operating liquidity of a business and is equal to the difference between a company's current assets and current liabilities. A company with a positive net working capital has the necessary funds to meet its current liabilities. In other words, NWC attempts to calculate the amount of money available to spend on day-to-day business operations as well as on investing and growing the business
Why is Net Working Capital Important?
Investors typically use net working capital as an indicator of a company’s short-term financial health. For example, a company with low, or even negative, NWC could encounter problems paying back debt or stimulating growth. However, high net working capital can also indicate underlying problems as well. For example, a company can have too much inventory or not be efficiently using its excess cash. Either an NWC too low or too high is not a good sign for a company.
Investors typically use net working capital as an indicator of a company’s short-term financial health. For example, a company with low, or even negative, NWC could encounter problems paying back debt or stimulating growth. However, high net working capital can also indicate underlying problems as well. For example, a company can have too much inventory or not be efficiently using its excess cash.
But how do you know if a company's NWC is too low or too high? You can compare its NWC margin (NWC/Revenue) with other companies in the industry. How can you do that? Simple! All you have to do is use the Finbox data explorer. Just follow these simple steps:
- Sign Up for free at Finbox.
- Go to the Finbox data explorer.
- Select the company and the metric you want to check (In this case we want to check the Net Working Capital Margin)
- Scroll down to Sector Benchmark Analysis
- Compare your company with the other companies in the industry (If your company is in the tail of the frequency distribution table, that's not a good sign. As you can see, Apple is at the center of the graph, so it's okay.)
How to calculate Net Working Capital with the right formula
There are several ways to calculate NWC, based on what an analyst is working on.
Net Working Capital = Current Assets - Current Liabilities
This formula is simply a liquidity measure. A company with a positive net working capital has the necessary funds to meet its current liabilities.
Net Working Capital = Account Receivable + Inventory - Accounts Payable
This formula is useful when dealing with the calculation or forecast of unlevered free cash flow. That's because changes in net working capital impact cash flow.
Net Working Capital Margin: Benchmarks by Sector
As of April 30, 2020, the sectors with the highest NWC margin are materials, industrials, and utilities. Financials, telecommunication services, and healthcare are the sectors with the lowest current ratios.
Net Working Capital Example [+ Excel Template]
I’ve created an example calculation of net working capital to try out. To explore the NWC of the 65,000+ companies that Finbox supports, just change the ticker in the spreadsheet. Click here to open the spreadsheet in Google Sheets. Select File > Make a copy to modify the example calculation. If you are not already registered on Finbox, all you have to do is sign up for free here.