Net working capital is a financial metric used to measure a company's operating liquidity or, in other words, its ability to meet day-to-day running costs, paying staff salaries and creditors' invoices.
Defining the net working capital of a business is done by taking its total current assets less its total current liabilities.
Current assets
Generally, current assets are anything a company owns that could be turned into cash, including:
• accounts receivable
• stock
• work-in-progress
• prepayments
• short-term investments
Current liabilities
In terms of net working capital, a current liability is any cost a company must settle within the next financial year such as:
• accounts payable
• staff wages
• tax due
• payment of short-term loans
Insufficient net working capital
When a business's current assets do not exceed its liabilities, it is no longer able to settle its short-term liabilities as they're due. This could mean not being able to pay staff or settle creditors' invoices on time, for instance.
In either case, this shortfall in net working capital has a negative impact on the company; if staff do not get paid, they may choose to leave; if your suppliers refuse to take any further orders, your ability to make any further sales is severely hampered.
Without sufficient day-to-day cash-flow, even the most profitable of companies can run into difficulty, or even fail. This risk can be mitigated by carefully balancing the current assets of a business against its current liabilities.