Net working capital (WCC) is a key indicator of a company’s short-term solvency—it reflects the difference between current assets and current liabilities. Positive WCC gives businesses more flexibility to manage cash flow and expand their business, while negative WCC can lead to financial risks and operational disruptions. To optimize WCC and cash flow effectively, businesses should take advantage of automated financial management tools such as accounting software, CRM, or real-time cash flow platforms.
In this article, Bizzi will decode the concept of what net working capital is, the formula and suggest tools to support business owners and accountants to make smarter financial decisions.
1. What is Net Working Capital? (NWC)
Basic concept: Net working capital is an important financial ratio that shows the difference between a company's current assets and current liabilities. In other words, it is the portion of current assets that is financed by long-term capital. The basic formula is:
Net Working Capital = Current Assets – Current Liabilities
In which, short-term assets include cash, receivables, inventories and assets that can be converted into cash within 12 months; short-term liabilities include payables, payable expenses and debts due within 12 months.
Other names: Net working capital.
Meaning: Net working capital is a key measure of a company's liquidity and ability to meet short-term financial obligations without experiencing cash flow difficulties. A positive NWC indicates that the company is able to pay short-term debts and maintain stable operations, while a negative NWC warns of liquidity and cash flow risks.
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2. Why is Net Working Capital Important to Businesses?
Net working capital is an important financial indicator that reflects a company's ability to manage short-term assets and short-term liabilities, thereby assessing operational efficiency and overall financial health.
- Ensuring solvency and stable operations: A positive NWC shows that the business is able to cover its daily expenses (salaries, raw materials, rent, etc.), keeping the business running smoothly.
- Support growth and expansion: A reasonable NWC level provides a “financial cushion”, allowing businesses to seize new investment opportunities without relying too much on short-term debt.
- Reflecting financial health and risk management: NWC is an early indicator of the ability to cope with economic fluctuations, helping management make timely decisions to maintain sustainability. Businesses can adjust their strategies cost management and cash flow to gain competitive advantage.
3. Net Working Capital Formula & Key Components
3.1. Simple & Easy-to-Understand Formula for Calculating Net Working Capital
What is net working capital?
Net Working Capital (NWC) is an important financial indicator that reflects a company’s short-term solvency and financial stability. This indicator indicates whether a company has enough current assets to cover its short-term debts.
Formula for calculating net working capital
Basic formula:
NWC=Current Assets−Current Liabilities
In there:
- Current assets: Includes cash, short-term receivables, inventories and assets that can be converted to cash within one year.
- Short-term debt: Includes debts that must be paid within one year, such as short-term loans, payables to suppliers, taxes payable, and salaries payable.
Alternative formula (based on long-term funding):
NWC=Long-term capital – Long-term assets
In there:
- Long-term capital: Includes equity and long-term debt.
- Long-term assets: Includes fixed assets and other assets with a useful life of more than one year.
Illustrative example
Suppose a business has the following figures:
- Current assets: 5 billion VND
- Short-term debt: 3 billion VND
Apply the basic formula:
NWC=5 billion VND−3 billion VND=2 billion VND
This means that the business has VND 2 billion in net working capital, showing its ability to pay short-term obligations and maintain business operations.
Meaning of net working capital
- NWC > 0: The business has enough current assets to pay short-term debts, showing a stable financial situation.
- NWC < 0: Businesses that do not have enough current assets to pay short-term debts may face liquidity difficulties.
- NWC = 0: The business has current assets equal to short-term liabilities, a balanced financial situation but no room to deal with risks.
3.2. Components Affecting Net Working Capital (On the Balance Sheet)
To understand more about net working capital (Net Working Capital – NWC), first, you need to understand the components of the balance sheet. Net working capital is the difference between the current assets and current liabilities of the business, reflecting the short-term solvency and financial flexibility. A detailed analysis of each component helps business owners and accountants accurately assess the financial situation and make appropriate decisions.
Current Assets
Current assets are assets that can be converted into cash within 12 months. They include:
- Cash and cash equivalents: Cash on hand, bank deposits, short-term highly liquid investments.
- Accounts Receivable: Customer debt, employee advances, tax refunds…
- Inventory: Raw materials, unfinished products, finished products.
- Prepaid expenses: Prepaid office rent, prepaid insurance…
Current Liabilities
Current liabilities are debts that must be paid within 12 months. They include:
- Accounts payable: Debt to suppliers, employee salaries, operating costs...
- Short term loan: Bank or credit institution loans with a term of less than 1 year.
- Tax payable: Value added tax, corporate income tax...
- Unearned Revenue: Customer pays in advance for services/products not yet provided.
Formula for Calculating Net Working Capital
The formula for calculating net working capital is as follows:
Net Working Capital = Current Assets – Current Liabilities
Understanding and analyzing these components helps businesses assess their short-term solvency and manage cash flow effectively. Especially for small and medium-sized enterprises, closely monitoring items on the balance sheet is very important to ensure stable and sustainable business operations.
4. The Meaning of Net Working Capital: “Reading” the Financial Health of a Business
Net Working Capital (NWC) is an important financial indicator that helps businesses assess their ability to pay short-term debts and maintain continuous business operations. Understanding the meaning of NWC helps business owners and accountants identify the current financial status and make timely decisions.
4.1. Positive Net Working Capital (>0): A Sign of Stability & Potential
Meaning: When NWC is positive, the company has more current assets than current liabilities, indicating good liquidity and low cash flow risk. This allows the company to maintain stable operations and flexibility in handling unexpected financial situations.
Advantages:
- High solvency: Ensure the ability to pay due debts such as suppliers, employee salaries, taxes, helping to maintain reputation and good relationships with partners.
- Easy access to loans: A healthy financial situation makes it easier for businesses to borrow money from banks or raise capital from investors to expand their business.
- Investment potential: Have enough resources to invest in new projects, improve production capacity and develop markets.
Note: However, too high NWC may reflect inefficient use of capital, such as large inventories or idle cash that has not been invested profitably. Therefore, it is necessary to consider and optimize the use of current assets to achieve maximum efficiency.
4.2. Negative Net Working Capital (<0): Warning of Liquidity Risk
Meaning: When NWC is negative, the business does not have enough current assets to cover its current liabilities, indicating an unstable financial situation and may have difficulty paying its financial obligations.
Risk:
- Payment difficulties: Businesses may have difficulty paying suppliers, employees and other expenses, affecting business operations.
- Risk of default: Without timely remedial measures, businesses may face the risk of insolvency or bankruptcy.
- Difficulties in raising capital: Weak financial situation makes it difficult for businesses to access loans or investment from outside sources.
Measure: To improve the situation, businesses need to:
- Financial restructuring: Review debt and asset structure to rebalance resources.
- Cash flow optimization: Tightly manage receivables, inventory and expenses to improve cash flow.
- Looking for additional funding: Consider suitable forms of capital mobilization such as bank loans, issuing shares or finding investors.
4.3. Net Working Capital Zero (=0): Potential Risks That Need to Be Assessed
Meaning: When NWC is 0, all current assets are financed by short-term capital, the business has no financial "buffer" to deal with unexpected fluctuations in business operations.
Risk:
- Lack of financial reserves: No backup resources to handle emergencies or investment opportunities.
- Sensitive to fluctuations: Even a small incident such as slow debt collection or inventory backlog can lead to insolvency.
- Difficulties in expanding business: Lack of capital to invest in new projects or expand production scale.
Recommendation: Businesses need:
- Keep a close eye on cash flow: Ensure cash flow is always stable and have a backup plan when needed.
- Effective asset management: Optimize the use of current assets for maximum efficiency.
- Timely assessment and adjustment: Continuously evaluate financial situation and adjust business strategy to ensure sustainable development.
5. Net Working Capital Needs of a Business: A Determinant of Operating Efficiency
Net working capital requirement is an important indicator reflecting the ability to maintain regular operations of the business. Good management of this indicator helps ensure liquidity, reduce financial risks and optimize business efficiency.
5.1. What is Net Working Capital Need?
Concept: Net Working Capital Requirement (NWC Requirement) reflects the amount of capital needed to maintain the daily business operations of the enterprise. This includes the management of inventory, receivables and payables. NWC Requirement helps the enterprise determine the amount of capital needed to maintain production and business operations without experiencing shortages or surpluses of capital.
5.2. Formula for Calculating Net Working Capital Requirement (WCR)
Recipe: WCR = Inventory + Accounts Receivable – Accounts Payable
Meaning: The WCR index helps businesses assess the level of "capital buried" in inventories and receivables. High WCR often shows that businesses are "burying" a lot of capital in inventories or receivables, or have not optimized payables, reducing the ability to invest in the future. Conversely, low WCR can show that businesses are effectively managing cash flow. working capital, minimizing financial risk.
5.3. Factors Affecting Net Working Capital Needs
NWC needs vary from business to business. It depends on:
- Business lines: The retail industry typically has large inventories, while the service industry focuses on managing receivables.
- Business cycle: Highly seasonal businesses need larger NWC during peak periods.
- Growth rate: Fast growing businesses need more NWC to finance expansion.
- Credit policy: Collection and repayment policies directly affect WCR.
6. Distinguishing Net Working Capital From Related Concepts
To avoid confusion, let's clarify the difference between Net Working Capital and related financial concepts:
6.1. Net Working Capital and Working Capital
To understand the effectiveness of short-term financial management, it is first necessary to distinguish between working capital and net working capital, two concepts that are often confused.
- Working Capital: Represents the total current assets of the business. This is pure short-term solvency. The value is usually positive.
- Net Working Capital: Is the difference between current assets and current liabilities. This is a measure of long-term funds used to finance current assets, and can be positive, negative, or zero.
6.2. Net Working Capital and Charter Capital
To assess overall financial health, it is important to distinguish between fixed capital and variable net working capital, as each reflects a different aspect of business management.
- Charter capital: Is the total capital that members/shareholders commit to contribute to the company upon establishment. This is a fixed number recorded on the business license.
- Net working capital: Is a volatile financial indicator, reflecting short-term solvency and financial flexibility in daily operations.
- Important Note: A company with large charter capital but poor NWC management can still face serious liquidity risks.
7. Optimize Net Working Capital With Technology Solutions From Bizzi
Effective management of Net Working Capital is not only a vital factor but also a competitive advantage for businesses in the digital age. Bizzi, as the leading enterprise cost management platform, provides comprehensive solutions to help businesses optimize each component of NWC.
7.1. General Methods for Effective Working Capital Management
To maintain stable operations and optimize financial resources, businesses need to apply scientific working capital management methods, balance revenue and expenditure, and take advantage of supporting technology.
- Accurate analysis of capital needs: Determine the optimal amount of NWC required for business operations.
- Optimize inventory management: Apply methods such as Just-in-Time (JIT) to reduce inventory while maintaining operations.
- Collect receivables quickly: Shorten the customer collection cycle.
- Effectively manage accounts payable: Take advantage of payment terms without compromising your supplier relationships.
- Technology application: Use financial management software to automate processes, provide real-time reporting, and make informed decisions.
7.2. Bizzi Financing – Comprehensive Working Capital Financing Solution for Businesses
In a volatile business environment, SMEs often struggle to maintain optimal net working capital (NWC). Temporary shortages can cause businesses to miss out on good import opportunities, delay payments to suppliers, or delay expansion projects. Bizzi Financing was born as a flexible financial solution, helping businesses easily access capital at reasonable costs and simple procedures, thereby ensuring stable cash flow and increasing competitiveness in the market.
Connecting businesses with fast and transparent capital
Bizzi Financing acts as a digital financial platform Directly connect businesses with the system of reputable banks and credit institutions. Through the mechanism of analyzing accounting data and cash flow in real time, Bizzi assesses the financial health of the business and suggests suitable credit limits. This helps businesses save time preparing documents, reduce cumbersome procedures and receive capital. within 24–48 hours without collateral.
Types of financing Bizzi Financing offers
Bizzi Financing focuses on two main financing models, which directly impact the components of net working capital:
- Supply Chain Financing (SCF)
- Help businesses pay suppliers early based on invoices and documents authenticated by Bizzi.
- Purchasing businesses can extend payment terms without affecting their reputation or relationships with suppliers.
- Suppliers receive money quickly, increase liquidity and continuously rotate capital.
- This is a solution especially suitable for trading and manufacturing enterprises with periodic import needs.
- Capital financing Working Capital Financing
- Provide flexible capital for businesses to pay operating expenses, pay debts, or seize short-term investment opportunities.
- Quick and simple procedures, no collateral required like traditional bank loans.
- Credit limits are determined based on financial data. has been automatically synchronized by Bizzi from the enterprise's accounting/ERP system.
Outstanding benefits when using Bizzi Financing
- Maintain NWC in a healthy state: Helps balance short-term assets and short-term liabilities, ensuring businesses always have enough resources to operate and expand.
- Real-time cash flow optimization: Integrated with Bizzi Invoice and Bizzi Expense systems, all invoice, debt and expense data is automatically synchronized, providing Instant cash flow statement for businesses to make informed decisions.
- Reduce financial costs: Competitive interest rates and service fees thanks to the multi-party connection mechanism between banks, investment funds and businesses, ensuring optimal borrowing costs.
- Security & Compliance: All transactions are conducted on a highly secure platform, in compliance with legal regulations and international data protection standards.
Practical application
For example: A manufacturing company has a large order from a customer but lacks capital to buy input materials. Instead of having to borrow from a bank with lengthy procedures, the business can use Bizzi Financing to pay suppliers immediately through the SCF model. Suppliers receive money early, businesses have more time to rotate cash flow while still maintaining reputation.
Thanks to this flexibility, Bizzi Financing helps SMEs reduce financial pressure, optimize net working capital and be ready to seize growth opportunities without being limited by short-term capital issues.
Experience Bizzi Financing today: finance.bizzi.vn
Additionally, Bizzi focuses on automating and optimizing core financial processes, which directly impact the components of Net Working Capital:
Input Invoice Processing and Reconciliation (IPA + 3-Way Matching)
Bizzi automates the loading, checking and reconciliation of invoices against Purchase Orders (POs) and Goods Receipts (GRs) in real-time. This process reduces errors, saves processing time and ensures the accuracy and timeliness of payables. This directly impacts Current Liabilities (accounts payable), helping businesses optimize cash flow, avoid late payment penalties and maintain good relationships with partners.
Business Expense Management (Bizzi Expense)
Bizzi Expense allows you to set budgets by department/project, monitor spending in real time and automate the approval process. This helps businesses keep a tight control on expenses, positively impact cash flow and ensure that the business has enough cash to meet short-term obligations, maintaining a healthy NWC.
Accounts Receivable Management (ARM)
Bizzi ARM tracks and reconciles receivables and key metrics such as Days Sales Outstanding (DSO), debt aging reports. Automatic reminders via email and scripted messages help speed up receivables collection, improve liquidity, increase current assets, and increase NWC.
ERP System Integration
Bizzi seamlessly integrates with leading ERP systems such as Oracle NetSuite, SAP, Microsoft Dynamics 365 Finance. This integration enables comprehensive financial data synchronization, improving NWC management efficiency through specialized automation of financial processes in existing ERP systems, providing a comprehensive and accurate view of the financial health of the enterprise.
To improve the efficiency of invoice management as well as automate the financial and accounting processes of the business. Register to experience Bizzi's comprehensive solution suite today!
- Link to register for a trial of Bizzi products: https://bizzi.vn/dang-ky-dung-thu/
- Schedule a demo: https://bizzi.vn/dat-lich-demo/
8. Conclusion
What is net working capital? and why is it important? Net working capital is not just a number on a financial statement but also a vital indicator, reflecting the liquidity and true financial health of a business. Understanding and effectively managing net working capital is the “key” to helping businesses maintain stable operations, seize growth opportunities and withstand market fluctuations.
In the context of digital transformation, the application of technology solutions such as Bizzi not only automates complex financial processes but also provides real-time insight into cash flow and net working capital components. As a result, businesses can make quick and accurate financial decisions, optimize net working capital and move towards sustainable development.
