What is working capital and how to calculate it?
What is working capital? The working capital is the amount of available money you have to run your business within each financial year.
If you want to know how to calculate working capital, there’s a formula that can help.
Working capital definition
Working capital, also known as net working capital, is the difference between your current assets and your current liabilities i.e. net current assets. This shows how much capital your business has overall… or not as we’ll discuss later in the glossary.
Understanding your business’s working capital is an essential part of your financial toolkit which will then enable you to successfully manage your business finances.
The working capital management strategy
Learning how to calculate your working capital or net working capital (NWC) is important, so you know how much money the business has to spend.
This is especially useful when considering external funding as investors will want to know this figure before they part with their cash.
It’s a good idea to work these calculations into your financial management strategy and stay up to date on the numbers.
You can calculate this figure manually with a formula, or use automated financial management software that can do it for you.
Working capital versus net working capital
So, what’s the difference between net working capital (NWC) and working capital?
The answer is that working capital is the term for the initial calculation that looks at assets. The NWC calculation takes into account any short term liabilities, like debts or accounts payable, to give a more accurate idea of what’s left.
The net working capital formula is:
Net working capital = current assets – current liabilities
Positive versus negative working capital
We’ve been talking about positive working capital, assuming your liabilities are less than your assets. So, what is the negative working capital meaning?
Negative working capital means that after performing the working capital calculation, your liabilities (debts, other liabilities, and outgoing payments) are more than what you are bringing in.
While this doesn’t necessarily mean an immediate problem as outgoing expenditure can fluctuate from month to month, you’ll want to plan your finances carefully and aim to turn this around. Especially if investors are looking closely at your financial data.
The working capital components
The components of working capital are assets like loans, cash, raw materials held like gold etc., investments, and accounts receivable.
While for net working capital calculations, you’ll need details of any liabilities like debts, expenses, sick pay, and accounts payable.
You can keep a working capital balance sheet to help keep track of these.
Working capital formula
The working capital formula is calculated by deducting your liabilities from your liquid assets (the things you own that are cash or can be converted to cash quickly with little loss of value).
The formula is, thankfully, simple:
Working capital = liquid assets – current liabilities
It is important to remember that inventory, property, or money owed from your customers are not included in your working capital calculation.
The end result is a balance sheet figure that tells you how much you currently have to spend on everything from wages to inventory.
Having a good working capital means you can cover your overheads and run your business. It’s a good measure of how well your business is doing.
