Net working capital

Last updated: 25.03.2016

Net working capital is obtained by subtracting short-term borrowings from (gross) working capital.

 

Calculation formula

working capital - short-term borrowings = current assets - short-term borrowings = long-term debt capital + equity – non-current assets

 

General interpretation of working capital and recommended values

the higher the value, the higher solvency and less risk; but too high values may indicate inefficiencies and lower profitability.

 

Net working capital is positive → over-capitalization, which means that:

  • long-term funds are higher than fixed assets
  • part of current assets are financed by long-term funds

lower risk (working capital serves as a buffer, because it is possible to use money raised from the potential sale of current assets financed by long-term sources for something else without compromising the stability of the entity)

lower efficiency because long-term funds tend to be more expensive than short-term

 

Net working capital is negative → under-capitalization, which means that:

  • part of non-current assets were financed by short-term resources

→ i.e. the risk that the company will be forced to sell this part of the fixed assets to be able to pay its debts

 

Net working capital should in any case be positive. Nevertheless, the optimum amount of working capital, which outweighs the risk and profitability, shall be ascertained. There is no general recommendation; it always depends on circumstances (industry, the proportion of working capital components, inventory, receivables and payables turnover ratios etc.).



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