A Detailed Guide on the Working Capital Formula to Calculate the Net Working Capital of Any Business

Home to the world’s fastest economy, India continues its success stride across its increased GDP owing to the contribution of its evolving business sector. While the nation’s GDP is expected to grow to approximately 7% in the FY 2018-19, it is strongly backed by its business industry, especially the start-ups. In an attempt to help start-ups meet their financial requirements, several funding options are available that primarily cater to this industry. 

Following this, a total of 108% growth of funding to USD 4.2 billion was witnessed in the present year. Boosting the industry’s opportunity for growth, this funding gave a substantial back up for their working capital. Considering the importance of this fund, business owners calculate their wealth by using the working capital formula.

This formulation helps a company decide its capability to pay off its existing financial liabilities against its existing assets. Since keeping track of the net working capital is crucial for the smooth functioning of a business, computing the same has been kept convenient via a formula. 

Working capital formula

All businesses, irrespective of the genre of its trade, need to check their working capital so that they have an in-depth idea about the current liabilities that need to be paid in the current year of business. Subsequently, both the creditors and the vendors have an approximate knowledge about the existing assets that are to be converted into cash. This cash so availed can be used to pay for the liabilities over the upcoming 12 months. 

Here is how to calculate the net working capital requirement for your business:

Networking capital (NWC) = Current asset – Current liabilities

-where 

Current assets – is equal to the total of short-term assets found on a business’ balance sheet that can be cashed within a year. It includes 

− Cash equivalents and cash like commercial paper, treasury bills, money market funds, and short-term government bonds

− Accounts receivable, marketable securities, and inventories.

Current liabilities – is equal to the short-term financial obligations that are due in 1 year or less. It includes 

− Accounts payable

− Short-term loans

− Current portion of long term advance like small business loans and commercial real estate credits

− Accrued liabilities

− Short-term loans

− Other debts like vendor notes, trade debts, and credit cards

Therefore, NWC is a crucial indicator of a business’ short-term liquidity; it reflects whether a company has adequate financing to invest in its growth and meet its current financial obligations. Subsequently, it is essential to increase the working capital of a business to ensure the smooth functioning of the same, thus helps your business stay agile. 

How to increase a business’s working capital?

Having adequate working capital lends in a certain flexibility enabling one to invest in new services and products, customise them as per customer demand, expand the business, etc. on the other hand, failing to maintain a positive cash flow, entrepreneurs can face a range of issues from late payments to suppliers to threats of liquidation. 

Here is what you can do to boost your networking capital –

  1. Increasing inventory turnover

Overstocking inventory is one sure-fire way to waste working capital, considering that the stocks are liable to perish over time. However, in case the current stock is a current asset, it can be sold off as a premium at a higher selling cost than its cost price. It adds on to the value of the working capital. 

2. Refinancing short-term debts with long-term one

approaching reputed lenders and availing a working capital loan helps business avail the necessary financing.

While cashing a business’ long-term asset can also increase your company’s working capital, approaching the lenders provides you with a credit amount that can be repaid across a flexible tenor. 

3. Earning Additional Profit

If it talks about earning an additional profit, as well as working capital, the other systems in your organization may be affected positively. Making extra profit is always a boon for any business or industry as one can be capable of maintaining its inventory and working capital in a natural way. 

4. Take Tax Incentive advantages

To fund your business, having benefits of tax incentive could be one of the affected ways. As however, it will push your working capital a little but get impact on it. 

5. Keep Financial Information Up to Date

If you are working strategically and keep a record of all the business transactions and finance, it will quickly help you out to calculate ratios on periodic time. With all this, you will have a clear picture of what is the status of your current working capital running and how much it is going to up or down according to the requirement. 

6. Good Relationship Between Customers and Vendors

Always it should be remembered that when you are a business professional, you should maintain a good relationship between your customers or your vendors. Maintaining a good relationship with your customers and vendors can definitely help you at the time of the cash crunch, which may be the cause of the worst working capital of your company. 

Following the above discussion may help you to have an eye on working capital requirements in your business so that you could lead by better cash flow management. 

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