The net working capital of the company is calculated as the difference between current assets and liabilities. In the usual sense, working capital is often equated with current assets. Likewise, current assets in the Russian balance sheet as a whole coincide with the concept of current assets, despite the fact that accountants often identify working capital with net working capital.
They also use the concept of working capital provided by operating activities. This economic category, which is also called the flow of funds received from operations, is associated with the sum of non-cash costs and net profit.
Current and net current assets and liabilities
Current assets include what can be converted into money in a fairly short time. Current liabilities include liabilities that need to be repaid in the near future. In the Russian accounting standard, you can find an explanation of a similar distinction between liabilities and assets. It is accepted that short-term and long-term values are delimited by a time period of one year. However, in order to develop, plan, and analyze financial policies, an organization often adopts its own time criteria. It all depends on the direction of its work, the profitability of its products and its position on the market.
These criteria are less significant for companies that require a quick turnaround of funds, for example, retail. And, on the contrary, for organizations with a slow turnover, for example, shipbuilding, these indicators take on more importance. A very important issue for the company is the coordination of payments on short-term assets and receipts on short-term liabilities.
The internal source that replenishes the net working capital is retained earnings and other accumulations, deferred or non-monetary expenses, such as tax arrears, depreciation and sale of non-current (fixed) assets. External sources replenishing working capital include trade and bank short-term loans, issue of securities and other loans, the funds from which were not invested in fixed assets.
Net Working Capital: Management Formula
An important objective of the company's economic policy is the management of net working capital. The reason for this lies in the fact that net working capital is not exactly accurate, but nevertheless a characteristic of the liquidity of the company, its ability to fulfill obligations, and the guarantee of the inadmissibility of bankruptcy. If current short-term liabilities exceed assets, we can say about a significant increase in the risk of insolvency of the company.
In addition, a large amount of net working capital may indicate a significant accumulation of unpaid receivables or illiquid, unrealized reserves (current liquidity is equal to the ratio of current assets and liabilities). This factor is the reason why net working capital cannot be an accurate measure of firm stability.
In addition, inventories, which are an important part of current assets, can be estimated using various methods, as a result, the amount of working capital can vary significantly. There is a certain pattern that shows that an increase in working capital means both an increase in the well-being of shareholders and a decrease in fixed capital or an increase in long-term debt.
Thus, the management of net working capital should solve the problem of finding the best balance between profitability and liquidity. As a rule, current assets have better liquidity, but lower profitability, in contrast to fixed assets.