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Net operating working capital (NOWC) is one measurement of a company’s financial health. It looks at how efficiently a company is managing its current assets and liabilities.
Unlike plain net working capital, net operating working capital excludes cash and cash equivalents, since they’re not tied up in operations. This means that net operating working capital is more closely tied to current cash flows and can serve as a more accurate indicator of a company’s ability to sustain cash flow in the face of changes or obstacles.
Read on to learn how to calculate net operating working capital, why it’s important, and how it differs from other measures of working capital – and to see an example of a NOWC calculation.
Key Points
• Net operating working capital (NOWC) measures a company’s financial health by examining the difference between operating current assets and operating current liabilities, excluding cash and cash equivalents.
• Lenders use NOWC to assess operational efficiency and determine whether a company can meet day-to-day expenses without taking on additional debt.
• The formula for NOWC subtracts operating current liabilities (accounts payable, accrued expenses, deferred revenue) from operating current assets (accounts receivable, inventory, prepaid expenses).
• Companies with positive NOWC demonstrate sufficient liquidity to cover short-term obligations, fund operational expenses, and invest in growth opportunities when they arise.
• Unlike traditional working capital, NOWC provides a narrower, more precise measure by focusing exclusively on assets and liabilities tied to daily operations.
• Businesses may be able to improve their NOWC by optimizing inventory levels, accelerating customer collections, negotiating better supplier payment terms, and increasing operational efficiency.
How Lenders View Net Operating Working Capital
Net Operating Working Capital (NOWC) essentially measures the operational efficiency of a company. It reveals whether the business has the wherewithal readily available to meet its day-to-day operational expenses without taking on additional debts. For lenders, it can help show how well a company is converting its inventory and receivables into cash. A good NOWC suggests that the day-to=day operations of a company are working effectively.
What Is Net Operating Working Capital?
To understand what net operating working capital is, it’s helpful to know what working capital is.
Working capital is the money available to meet your current (short-term) obligations. It’s calculated by subtracting current liabilities from current assets, as listed on the company’s balance sheet. Current assets are those that can be converted into cash within one year; current liabilities are obligations expected to be paid within one year.
Net operating working capital measures the difference between a firm’s current assets, such as inventory and accounts receivable, and its current liabilities, such as accounts payable and accrued expenses. Unlike net working capital, however, it excludes cash and cash equivalents, such as bank deposits and short-term investments, since they are not tied up in operations and can be converted into cash if needed.
NOWC also excludes debt (such as different types of small business loans) and interest-bearing securities, since these items represent a method of raising the necessary capital to fund ongoing operations.
Key Components
The assets and liabilities that are tied to operations are the crucial components of NOWC.These include:
• Operating Current Assets. These are assets such as inventory and accounts receivable, which are needed to generate the company’s core revenue
• Operating Current Liabilities: These are short-term costs such as accounts payable and any accrued expenses.
Unlike NWC, NOWC does not include cash and cash equivalents, but focuses exclusively on operating assets and liabilities.
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What Is Net Operating Working Capital Used For?
Calculating NOWC provides a measure of your company’s liquidity — or, in other words, its ability to meet its short-term financial obligations. Having a high NOWC, for example, means it’s likely easier to pay your bills as they come due. In contrast, having a low NOWC means you risk not having sufficient funds to pay off outstanding liabilities and may not be able to remain solvent.
Once you have calculated your business’s NOWC, you can use it to analyze your firm’s financial health and compare it to industry benchmarks or its historical performance.
And there are several more ways this information can be useful to you.
Supporting Business Growth
Knowing your business’s NOWC can give you a good sense of how well-positioned your business is to grow. Having a high NOWC allows you to invest in growth opportunities when they come up and increase profits. If, on the other hand, your business has too little NOWC, it will probably lack funds to invest in future growth.
Evaluating Operational Efficiency
Operational efficiency means how well your business manages its resources to arrive at desired outputs, like revenue. Since NOWC focuses on operations and compares your company’s relevant assets and costs, a high NOWC can suggest that your business is optimizing its resources.
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Net Operating Working Capital Formula
Here’s a look at the net operating working capital formula:
Net Operating Working Capital (NOWC) = Operating Current Assets – Operating Current Liabilities
Operating current assets can include:
• Accounts receivable
• Inventory
• Prepaid expenses
Operating current liabilities can include:
• Accounts payable
• Accrued expenses
• Deferred revenue
Calculating Net Operating Working Capital
To calculate net operating working capital, you need to:
1. Determine your company’s current assets. These are assets that are expected to be converted into cash within one year. Examples include accounts receivable, inventory, and prepaid expenses. You can find your company’s current assets listed on its balance sheet.
2. Determine your company’s current liabilities. These are debts that are expected to be paid within one year. Examples include accounts payable and accrued expenses. You can find a company’s current liabilities listed on its balance sheet.
3. Exclude cash and cash equivalents. Cash and cash equivalents are excluded from the NOWC formula because they aren’t tied up in a company’s day-to-day operations. These include bank deposits and short-term investments.
4. Calculate net operating working capital. Subtract your company’s current liabilities (excluding any short-term loans that have been used to finance current assets) from its current assets (excluding cash and cash equivalents).
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Working Capital vs Net Operating Working Capital
| Working Capital | Net Operating Working Capital | |
|---|---|---|
| What it measures |
• Looks at all current assets and current liabilities |
• Looks only at current assets and liabilities related to daily operations |
| Focus |
• Broader |
• Narrower |
| Cash and short-term debt included? |
• Yes |
• No |
| Uses |
• Look at a firm’s overall profitability |
• Helps determine if a company can remain solvent |
Net operating working capital (NOWC) and net working capital (NWC) are both financial metrics that can be used to evaluate a company’s liquidity and overall financial health. NWC, however, includes all of a company’s current assets and liabilities, including cash and cash equivalents. It’s calculated by subtracting a company’s current liabilities from its current assets.
NOWC, on the other hand, is a narrower measure that excludes cash and cash equivalents from current assets, as well as short-term debt that has been used to finance current assets from current liabilities.
NOWC is calculated by subtracting a company’s current liabilities (excluding any short-term debt used to finance current assets) from its current assets (excluding cash and cash equivalents).
As a result, NOWC tends to be a more precise measure of a company’s ability to fund its day-to-day operations. It hones in on the capital a company has tied up in its day-to-day operations, which is more relevant for short-term financial management.
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Net Operating Working Capital Example
Here is an example of how to calculate net operating working capital for fictional company ABC.
ABC’s operating current assets are:
Accounts Receivable = $5 million
Inventory = $30 million
Prepaid Expenses = $4 million
Total operating current assets = $39 million
ABC’s operating current liabilities are:
Accounts payable = $10 million
Accrued expenses = $7 million
Deferred revenue = $3 million
Total operating current liabilities = $20 million
We then plug these numbers into the NOWC formula:
Net Operating Working Capital (NOWC) = Operating Current Assets – Operating Current Liabilities
NOWC = $39 million – $20 million
NOWC = $19 million
Based on the operating working capital formula, ABC has a positive NOWC, which means it is capable of paying off all of its current operating liabilities and having some assets left over. This indicates that things are probably going well — ABC could meet its obligations all at once if needed and still have funds left to cover its current operations.
Common Mistakes When Calculating NOWC
One mistake it can be easy to make when you’re figuring out your company’s NOWC is to include cash or cash equivalent assets and/or short-term debt. Since these don’t pertain to operations, they should not figure in a NOWC calculation.
If your business is subject to seasonal swings, you may also get a misleading NOWC result if you focus on a specific moment in time, rather than using a longer time range or average.
The Takeaway
Net operating working capital measures a company’s short-term liquidity, meaning its ability to meet short-term financial obligations. If a company has a positive NOWC, it’s able to cover all of its liabilities. If it doesn’t, some aspects of the business are likely not operating as well as they could.
Some ways to improve your company’s NOWC include optimizing inventory levels to improve efficiency and cash flow, improving collections from customers, negotiating better payment terms with your suppliers, and increasing operational efficiency.
You might also consider financing options, such as a working capital loan, which can provide short-term financing to cover operating expenses or factoring, where you sell accounts receivable to a third party for cash.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How are operating capital and operating working capital different?
Operating capital and operating working capital are the same thing: capital required to fund a company’s day-to-day operations. They can cover operational expenses, including accounts payable and accrued expenses.
What does net operating working capital include?
To calculate net operating working capital (NOWC), you subtract operating current liabilities (such as accounts payable, accrued expenses, and deferred revenue) from operating current assets (such as accounts receivable, inventory, and prepaid expenses).
What is net operating working capital an indicator of?
Net operating working capital (NOWC) is an important indicator of a company’s short-term liquidity and its ability to meet day-to-day operational expenses. A positive NOWC indicates that a company has sufficient current assets to cover its short-term obligations, while a negative NOWC suggests potential liquidity issues.
How can a business improve its net operating working capital?
Possible ways to improve your business’s NOWC can include optimizing inventory levels, negotiating with your suppliers to get better rates, improving your collections from customers, and boosting the efficiency of your operations.
Is a higher net operating working capital always better?
While a high NOWC can be a good sign, in certain situations it may signal a problem. Your business might have a high NOWC because you have too much inventory that is not moving, for instance.
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