Change in Working Capital

Running a business comes with its share of financial responsibilities. Accounting is all about keeping track of every dollar and every last penny. A business without good accounting professionals is bound to fail. Just like a car needs its own engine control unit for monitoring its functioning, a company needs its accounting department. There are various financial constructs and calculations, which are used in accounting to analyze the performance of a company. One of the most important ones is the net working capital of the company. It is closely related to the degree of liquidity that is available to a company for day-to-day operations. In the following lines, you will find an explanation of what is working capital and how to calculate change in working capital of any business.

What is Net Working Capital?

It is essential that the basic concept of what is net working capital be known, before we talk about how to calculate changes in it. It is one of the most basic concept in accounting when it comes to evaluating the financial condition of a company. As the name itself suggests, working capital is the cash available for the daily operations of the company.

The net working capital can be defined as the difference between total current assets of the company and its current liabilities. The current assets of the company include its inventory and accounts receivable, while the liabilities include the accounts payable. Securities and investments are also included in current assets, while current liabilities may also include debt, when calculating the net working capital. Thus the formula for calculating net working capital is:

Net Working Capital (WC) = Current Assets - Current Liabilities

When there is a change in working capital which may happen due to a number of reasons. Either there has been a spurt in the accounts receivable or there is a decrease in the number of liabilities. Analyzing the reason for change will require that you investigate the change in current assets and the amount of liabilities. If you want to look at cash flow, the operating working capital is a better choice as it only monitors the accounts receivable and accounts payable.

How to Calculate Change in Working Capital?

Now that I have explained how to calculate working capital, we can attack the question of how to calculate the change in working capital. I think the method for calculation will be clear after you have seen the above formula for working capital. The change in working capital formula is the same one.

To calculate working capital change in two successive years, you need to calculate the net or operating working capital for both years and simply subtract the second year's value from the first year's amount. For successive years, you must do the same change in working capital calculation.

The change in operating working capital will demonstrate the changes in cash flow, while the change is net working capital, will highlight the macroscopic changes in the fortunes of the company. For example, consider that the operating working capital for year 2009 of a certain company is $90,000, while the successive year sees, it rising to $120,000. Then the change in working capital cash flow will obviously be $30,000, which is good news for the company.

As you can see, calculating change in working capital is a simple exercise, if you have all the data needed for calculation. The total change in net working capital over a few years can reveal the progress made by the company in revenues, as more cash becomes available for its operations. A positive change in working capital of a company is an important indicator of its overall progress, while a negative change in working capital indicates a drop in sales. When comparing the balance sheets of successive years for a company, one needs to monitor this net working capital change. Hope, this article has cleared out all the doubts you might have regarding changing working capital calculation and its significance.