As we have already emphasized in several posts on this blog, working capital is the magic that makes the company happen. He pays for employees, energy, the internet, rent, and all other short-term bills. Today we are going to talk more specifically about net working capital, which is the running share of total capital. A summay is on combustion-net.com
The importance of working capital
In almost all companies, the accounts are paid a posteriori , that is, after consumption of the product or service. However, as the final consumer approaches, the delivery deadlines are also stretched. In general, the deadlines granted by manufacturers and distributors are lower than those of retailers.
In practice, most companies need some recourse to cover the difference between payment and receipt terms. This resource is working capital, which can be presented in the form of trade notes, raw materials, inventories or cash.
Without working capital , technology, machines, employees, etc. do not matter. nothing will work and there will be no profit. The short-term resources are those that can transform the inputs into profit, everything else is advisory activity.
What is specifically the net working capital?
While total capital is measured by the difference between assets and liabilities, the CGL considers only the circulating shares. The net working capital then comes to be represented by the formula: CGL = AC – PC.
As we know, current assets are all that will be transformed into cash in up to 12 months. The current liabilities are the accounts that must be settled in up to 12 months. In order to know the amount of capital necessary for the operation of the company, it is necessary to use the working capital requirement .
Through the CGL, the company can know the volume of capital necessary to the healthy operation of the business of the firm. The CGL shows the efficiency that the company is having in financing its short-term operations through long-term resources. The larger the CGL, the more liquid the company is, and the smaller the riskier the business.
Calculating CGL in practice
Before we perform the calculation of the GLS, it is necessary to differentiate the current assets and liabilities from the non-current assets. Some examples are given below:
- Current Assets
– cash and banks
– Duplicates to receive
– financial investments
- Current liabilities
– suppliers payable
– taxes to pay
– wages to be paid
– short-term loan
Since it is already known to identify short-term liabilities and assets, it is time to calculate the CGL. Let’s calculate the net working capital of company X.
The Company’s current assets totaled $ 470, while current liabilities totaled $ 620. In this case the net working capital will be – $ 150, that is, the company is experiencing liquidity difficulties. Financial managers should seek ways to power their box to cover this vacuum.
Generally, increases in cash and cash equivalents solve this problem, which can be done through working capital loans. If the company persists in this situation for long periods, it will surely go into insolvency and go bankrupt.
The effect of the cost of net working capital on the company’s results
The net working capital has a cost, which will vary according to the sources of supply of this capital. If the net working capital is from its own sources, its cost will be the interest rate of the economy, but if it comes from third parties, its cost will be that of the interest rate charged by the financial institution. The total cost will always be the weighted average cost and proportion of net working capital.
If the company finances its working capital with loans, its financial result will be adversely affected by the interest rate. However, raising capital via loans can raise revenues, thus increasing profit. It is therefore ideal to finance liquid working capital through simple and inexpensive sources. Good sources are for example, fintechs such as Biz Capital.
Factors affecting net working capital
Some factors must be monitored as they significantly affect net working capital. Such changes may be for better or for worse.
- Affect Positive Way
– Increase in the balance of accounts receivable
– Increases in cash and cash equivalents
– Increase in sight sales
– Reduction of delivery times
– Higher payment deadlines
– Reduction in the balance of accounts payable and taxes to be collected
– Profit Reserve
- Affect Negatively
– Disproportionate increase in short-term indebtedness
– Emptying the carton
– Increased time limits granted
– Reduction of payment deadlines
It is important to understand that net working capital is not the necessary volume of capital to operate. This number is given by the NCG (working capital requirement). The CGL is a liquidity measure, which verifies whether the company is able to finance itself in the short term.
In order to improve the net working capital ratio, the ideal is to increase cash. Specific working capital loans have exactly this function, making it possible to operate the company in the short term.
The net working capital will tell you whether the company is being well-managed or not. Little will advance an organization, have an excellent team, good products and great marketing, if there is no working capital. Without the health of this essential indicator, all technical and administrative effort will be lost.
So, did you like this article? We at BizCapital are here to help business owners who want to see their business take off! Keep an eye on our blog and check out other tips on the world of entrepreneurship.