Net Working Capital

What is Net Working Capital?

Simply put, Net Working Capital (NWC) is the difference between a company’s current assets and current liabilities on its balance sheet. It is a measure of a company’s liquidity and its ability to meet short-term obligations, as well as fund operations of the business. The ideal position is to have more current assets than current liabilities and thus have a positive net working capital balance.

NWC is most commonly calculated by excluding cash and debt (current portion only).

Image: CFI’s Financial Analysis Fundamentals Course.

Net Working Capital Formula

There are a few different methods for calculating net working capital, depending on what an analyst wants to include or exclude from the value.

Formula:

Net Working Capital = Current Assets – Current Liabilities

or,

Formula:

Net Working Capital = Current Assets (less cash) – Current Liabilities (less debt)

or,

NWC = Accounts Receivable + Inventory – Accounts Payable

The first formula above is the broadest (as it includes all accounts), the second formula is more narrow, and the last formula is the most narrow (as it only includes three accounts). Learn more in CFI’s Financial Analyst Training Program.

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Setting up a Net Working Capital Schedule

Below are the steps an analyst would take to forecast NWC using a schedule in Excel.

Step 1

At the very top of the working capital schedule, reference sales and cost of goods sold from the income statement for all relevant periods. These will be used later to calculate drivers to forecast the working capital accounts.

Step 2

Under sales and cost of goods sold, lay out the relevant balance sheet accounts. Separate current assets and current liabilities into two sections. Remember to exclude cash under current assets and to exclude any current portions of debt from current liabilities. For clarity and consistency, lay out the accounts in the order they appear in the balance sheet.

Step 3

Create subtotals for total non-cash current assets and total non-debt current liabilities. Subtract the latter from the former to create a final total for net working capital. If the following will be valuable, create another line to calculate the increase or decrease of net working capital in the current period from the previous period.

Step 4

Populate the schedule with historical data, either by referencing the corresponding data in the balance sheet or by inputting hardcoded data into the net working capital schedule. If a balance sheet has been prepared with future forecasted periods already available, populate the schedule with forecast data as well by referencing the balance sheet.

Step 5

If future periods for the current accounts are not available, create a section to outline the drivers and assumptions for the main assets. Use the historical data to calculate drivers and assumptions for future periods. See the information below for common drivers used in calculating specific line items. Finally, use the prepared drivers and assumptions to calculate future values for the line items.

Video Explanation of Net Working Capital

Below is a short video explaining how the operating activities of a business impact the working capital accounts, which are then used to determine a company’s NWC.

Common Drivers Used for Net Working Capital Accounts

Below is a list of assumptions that are used in a financial model to forecast NWC:

• Accounts Receivables: Accounts Receivable Days
• Inventory: Inventory Days
• Other Current Assets: Percentage of sales, growth percentage, fixed amount, or increasing amount
• Accounts Payable: Accounts Payable Days
• Other current liabilities: Percentage of sales, growth percentage, fixed amount, increasing amount

Accounts receivable days, inventory days, and accounts payable days all rely on sales or cost of goods sold to calculate. If either sales or COGS is unavailable, the “days” metrics cannot be calculated. When this happens, it may be easier to calculate accounts receivables, inventory, and accounts payables by analyzing the past trend and estimating a future value.

Use of Net Working Capital in Financial Modeling

Changes in net working capital impact cash flow in financial modeling.

Look closely at the image of the model below, and you will see a line labeled “Less Changes in Working Capital” – this is where the impact of increases/decreases in accounts receivable, inventory, and accounts payable impact the unlevered free cash flow of a firm.

Understanding the impact of changes in net working capital is extremely important in financial modeling and corporate valuation. To learn more, check out CFI’s financial modeling courses now!

Additional Resources

This has been CFI’s guide to Net Working Capital. To advance your career as an analyst, read more about the other elements that populate financial statements:

• Core Statements
• Income Statement
• Cash Flow Statement
• Net Working Capital Template
• See all valuation resources