Net Operating Working Capital
Net operating working capital (NOWC) is the excess of operating current assets over operating current liabilities. In most cases it equals cash plus accounts receivable plus inventories minus accounts payable minus accrued expenses.
Operating current assets are assets that are (a) needed to support the business operations, and (b) expected to be converted to cash in next 12 months. They do not include current financial investments.
Operating current liabilities are liabilities that are (a) undertaken to carry out the business operations, and (b) expected to be settled in next 12 months. They exclude any current loans or interest bearing liabilities.
Net operating working capital is different from (net) working capital which simply equals current assets minus current liabilities. NOWC is an intermediate input in the calculation of free cash flow. Free cash flow equals operating cash flow minus gross investment in operating assets minus investment in net working capital.
Formula
Net Operating Working Capital
= Current Operating Assets
− Current Operating Liabilities
In many cases, the following formula can be used to calculate NOWC:
Net Operating Working Capital
= (Cash + Accounts Receivable + Inventories)
− (Accounts Payable + Accrued Expenses)
Example
Let us calculate net operating working capital for IBM (NYSE: IBM) for financial year 2012.
| Total | Operating | Non-operating | |
|---|---|---|---|
| CURRENT ASSETS | |||
| Cash and cash equivalents | 10,412 | 10,412 | |
| Marketable securities | 717 | — | 717 |
| Notes and accounts receivable-trade | 10,667 | 10,667 | |
| Short-term financing receivables | 18,038 | — | 18,038 |
| Other accounts receivable | 1,873 | 1,873 | |
| Inventories | 2,287 | 2,287 | |
| Deferred taxes | 1,415 | 1,415 | |
| Prepaid expenses and other current assets | 4,024 | 4,024 | |
| Subtotal | 49,433 | 30,678 | 18,755 |
| CURRENT LIABILITIES | |||
| Taxes | 4,948 | 4,948 | |
| Short-term debt | 9,181 | — | 9,181 |
| Accounts payable | 7,952 | 7,952 | |
| Compensation and benefits | 4,745 | 4,745 | |
| Deferred income | 11,952 | 11,952 | |
| Other accrued expenses and liabilities | 4,847 | 4,847 | |
| Subtotal | 43,625 | 34,444 | 9,181 |
Net Working Capital
= Current Assets − Current Liabilities
= $49,433M − $43,625M
= $5,808 million
Net Operating Working Capital
= Operating Current Assets − Operating Current Liabilities
= $30,678M − $34,444M
= -$3,766 million
Low working capital and low net operating working capital together with unfavorable current ratio, quick ratio, days sales in receivable and days sales in inventory indicate liquidity problems.
by Obaidullah Jan, ACA, CFA and last modified on