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Net working capital definition

Description

NWC is a financial metric which represents the amount, by which the value of a company's current assets exceeds its current liabilities. Data, needed to calculate this ratio is collected from the balance sheet. It is a very commonly used measure of the company’s liquidity. In conjunction with other financial ratios, net working capital indicates how well company manages its short-term debts and uses current assets.

A term “Net working capital” is also used as NWC. This measure is also known as working capital or even working capital ratio. Net working capital is an important metric measure which can be often found in financial reports. It is used both by the company’s investors and owners. Both of them are concerned about net working capital not being very high (it could mean ineffective management). On the other hand it can’t be very low, as it would indicate solvency problems.

Norms and limitations

Negative value of the working capital indicates a great risk for the company to be unable to meet its short-term liabilities, on the other hand the positive value of this measure shows company’s ability to pay off its short-term liabilities.

Constantly decreasing NWC can indicate that the company is starting to face some problems when covering its short-term debts. However in some cases a decrease of this measure may show that the company manages its short-term assets and liabilities more efficiently. So it is useful to compare the working capital from one period to another.

Formula

Current liabilities, also known as short-term debts, indicate debts that must be covered in a period of 12 months.

Current asset is a value that represents such company’s assets inventories, receivable accounts, cash and other assets that are reasonably expected to be converted into cash within the period of 12 months.