What is Net Operating Working Capital?
How do you calculate the net operating working capital?
What should you know?
In this article, we will break down the notion of Net Operating Working Capital so you know all there is to know about it!
Keep reading as we have gathered exactly the information that you need!
Let’s dig into our finance, accounting, and financial formula knowledge!
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What Is Net Operating Working Capital
The “net operating working capital” or NOWC is the value in excess of a company’s operating current assets over the operating current liabilities.
Operating current assets are
(Cash + Account Receivables + Inventories) – (Accounts Payable + Accrued Expenses)
Operating liabilities are commitments that are required to be settled within twelve months but exclude loans and interest-bearing debt obligations.
With the net “operating” working capital, the objective is to get a measure of the cash flow available to a company from its operations.
The objective of the “net operating” working capital is to measure how efficiently a company uses its resources to operate its business.
This measure is closely related to the Net Working Capital (NWC) but not the same.
The net working capital provides a calculation of how a company uses all its current assets and current liabilities whereas the net operating “working capital” looks at balance seet accounts such as:
- Accounts receivable
- Accounts payable
- Accrued expenses
Net Operating Working Capital Formula
How to calculate net operating working capital?
You can calculate the NOWC by using the following formula:
NOWC = COA – COL
- COA = Current Operating Assets
- COL = Current Operating Liabilities
This formula measures a company’s operating assets compared to its operating liabilities.
If the operating assets are sufficient to pay for the company’s operating liabilities, the result of this calculation will be positive.
The net operating capital formula is an important one as it provides a measure of how a company uses its resources in its operations.
Net Operating Working Capital vs Net Working Capital
Net Working Capital (NWC) is not the same thing as the Net Operating Working Capital (NOWC).
In essence, the net working capital is the current assets less the current liabilities as depicted by the following formula:
Net Working Capital = Current Assets – Current Liabilities
On the other hand, net operating working capital is more focused on the operating cash flow depicted by the following formula:
Net Operating Working Capital = Current Operating Assets – Current Operating Liabilities
Net Operating Working Capital vs Total Operating Capital
What is the difference between net operating working capital and the total operating capital?
In essence, the NOWC is part of the TOC.
To calculate total operating capital, you need to take the NOWC and add the company’s fixed assets.
In the net operating working capital, you have:
- Cash account
- Accounts receivable account
- Inventory account
- Accounts payable account
- Accrued expenses account
To get the total operating capital, you’ll need to add the fixed assets such as:
- Office furniture
- Other fixed assets
The TOC provides a company, investor, accountant, or anyone assessing a company’s financial position with a broader picture.
Let’s look at a NOWC example to better illustrate how to calculate net operating working capital.
Let’s assume the following parameters for a company found in its income statement:
- Cash: $100,000
- Accounts Receivables: $75,000
- Inventory: $500,000
- Accounts Payable: $250,000
- Accrued Expenses: $150,000
With this information, you can calculate NOWC by doing the following net operating capital calculation:
- Current Operating Assets = $100,000 (Cash) + $75,000 (AR) + $500,000 (Inventory) = $675,000
- Current Operating Liabilities = $250,000 (AP) + $150,000 (AE) = $400,000
Therefore, NOWC is $675,000 – $400,000 = $275,000
This means that the company has $275,000 over and above what it needs to fully pay off its operating expenses.
In this example, this financial measure alone may suggest that the company is in good financial health (but NOWC alone does not tell the full story).
Net Operating Capital Takeaways
So what is the financial definition of Net Operating Working Capital?
Let’s look at a summary of our findings.
Net Operating Working Capital Definition
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