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).
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.
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.
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.
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.
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.
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:
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.
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.