Change in Net Working Capital Formula

Change in Net Working Capital Formula (Table of Contents)

Change in Net Working Capital Formula
Examples of Change in Net Working Capital Formula (With Excel Template)
Change in Net Working Capital Formula Calculator

Net Working capital, in very simple terms, is basically the amount of fund which a business needed to run its operations on a daily basis. In other words, it is the measure of liquidity of business and its ability to meet short term expenses. Change in Net Working Capital is calculated as a difference between Current Assets and Current Liabilities. So higher the current assets or lower the current liabilities, higher will be the net working capital.

Sometimes, an increase/decrease in working capital will not give the exact picture. For example, a business is expanding and therefore they have increased their short term liabilities to meet the demand. So that is not bad for business. So to get a better understanding of the company’s cash position, change in net working capital formula is used. This is change is working capital from one period to another and it is really important to track the changes to monitor operating cash flows

A formula for Net Working Capital –

There are various ways, depending upon what to include, used by analysts to calculate Change in net working capital:

Net Working Capital = Current Assets – Current Liabilities

Sometimes, analysts exclude cash and debt from the current assets and current liabilities:

Net Working Capital = Current Assets (Less Cash) – Current Liabilities (Less Debt)

Net Working Capital = Accounts Receivable + Inventory + Marketable Investments – Trade Accounts Payable

A formula for Change in Net Working Capital is given by:

Change in Net Working Capital = Net Working Capital for Current Period – Net Working Capital for Previous Period

Methods for Calculating Change in Net Working Capital

Following are the steps to calculate a change in net working capital:

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Determine Current Assets from the company’s balance sheet for the current and previous period. Current assets include Inventory, Receivables, prepaid expenses, etc.
Determine Current Liabilities from the company’s balance sheet for the current and previous period. Current liabilities include accrued expenses, payables, deferred revenue, etc.
Find net working capital for the current and previous period

Working Capital for Current Period = Current Assets for Current Period– Current Liabilities for the Current Period
Working Capital for Previous Period = Current Assets for Previous Period – Current Liabilities for the Previous Period

Calculate the change in net working capital by taking a difference of the calculated working capitals.

Examples of Change in Net Working Capital Formula (With Excel Template)

Let’s take an example to understand the calculation of Change in Net Working Capital formula in a better manner.

You can download this Change in Net Working Capital Template here – Change in Net Working Capital Template

Change in Net Working Capital Formula – Example #1

Let say company A has the following values of current assets and current liabilities for the year 2017 and 2018. Calculate its Change in Net Working Capital.

Solution:

Net Working Capital is calculated using the formula given below

Net Working Capital = Current Assets – Current Liabilities

For 2017

Net Working Capital = 30,000 – 23,000
Net Working Capital = 7,000

For 2018

Net Working Capital = 33,000 – 21,000
Net Working Capital = 12,000

Change in Net Working Capital is calculated using the formula given below

Change in Net Working Capital = Net Working Capital for Current Period – Net Working Capital for Previous Period

Change in Net Working Capital = 12,000 – 7,000
Change in Net Working Capital = 5,000

Since the change in net working capital has increased, it means that change in current assets is more than a change in current liabilities. So current assets have increased. It means that the company has spent money to purchase those assets. So this increase is basically cash outflow for the company.

Change in Net Working Capital Formula – Example #2

Let take an example of Amazon and calculate its Change in Net Working Capital.

Below is the snapshot of Amazon’s Balance sheet for the year 2017 and 2018 :

Source Link: https://in.finance.yahoo.com/quote/AMZN/balance-sheet?p=AMZN&.tsrc=fin-srch-v1

Using the above data points, we have the following information:

Solution:

Net Working Capital is calculated using the formula given below

Net Working Capital = Current Assets – Current Liabilities

For 2017

Net Working Capital = 60,197,000 – 57,883,000
Net Working Capital = 2,314,000

For 2018

Net Working Capital = 75,101,000 – 68,391,000
Net Working Capital = 6,710,000

Change in Net Working Capital is calculated using the formula given below

Change in Net Working Capital = Net Working Capital for Current Period – Net Working Capital for Previous Period

Change in Net Working Capital = 6,710,000 – 2,314,000
Change in Net Working Capital = 4,396,000

Explanation

Working capital is a very important concept and it helps us to understand the company’s current position. When a company has more current assets than current liabilities, means that positive working capital, it implies that it can easily cover its short term expenses. So positive working capital symbolizes good financial strength. But bear in mind that constant excessive working capital can lead to the inference that the company is not managing its assets efficiently. On the same line, Negative working capital does not mean that it is bad. It can be the case that the company has purchased something to expand its business. But if it is negative for a long time, it can imply that a company is in a difficult position.

Similarly, change in net working capital helps us to understand the cash flow position of the company. So if the change in net working capital is positive, it means that the company has purchased more current assets in the current period and that purchase is basically outflow of the cash. So a positive change in net working capital is cash outflow. Similarly, negative change in net working capital means that current liabilities has increased in this period. So this can be in the form of increased payables etc. which means that we have cash inflow. So negative change in the working capital is cash inflow.

Relevance and Uses of Change in Net Working Capital

Working capital is part of a company’s daily operations and they need to monitor it on a regular basis. Net Working capital is very important because it is a good indicator regarding how efficiently a business operation is and solvent the business is in short-run. If a company is not able to meet its short term liabilities with current assets, they will not have any other option but to use noncurrent assets and because of which it will lead to operational and financial problems.

Similarly change in net working capital, as discussed above, is also a very critical component in determining the cash position of the business. Companies need cash to operate and if they do not have a sufficient amount of cash balances, they might have to face a difficult time. Drastic positive change in net working capital means that cash balance is reducing very rapidly and if unprecedented circumstances arrived, companies have to sell their fixed assets to pay off.

In nutshell, business managers should keep a close eye on the change of working capital and raise a flag if it is going out of control.