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Laurence J. Peter

Working Capital Calculation

 

There are few modifications of working capital calculation. All data that are needed for working capital calculation can be found in balance sheet (which is one the three main financial statements). 

 

Working capital formula


(1) Working capital = Current assets – Current liabilities


(2) Operating working capital = Non-financial current assets* – Non-financial current liabilities = Inventories + Receivables + Prepayments made – Trade payables – Accrued liabilities = (Current assets – Financial current assets*) – (Current liabilities – Financial current liabilities)


* If cash is necessary for the business (for example retail trading when cash is used in activity), then part of cash that is needed for the business should be considered as non-financial asset in case of working capital calculation.


Operating working capital = Non-cash working capital 

 

As you may see there are two main approaches in working capital calculation. Standard (more used by accountants) approach includes all current assets and liabilities when other approach is clearer (more used by investment banking analysts) and do not includes financial assets and liabilities.

 

There are many names of working capital: working capital, net working capital, operating working capital, non-cash working capital and others. If theoretically some of them may have some differences in practice they all can be mixed depending on the analyst and his experience. 

 

Traditional and most common is standard (1) calculation of working capital but non-cash (2) approach is more exact should be used more for comparison and for working capital ratio as well. The reality is that many companies are accumulating cash for different reasons (for extra safety, for large acquisition etc.) and if there is no real need for that cash it is hard to describe it as working capital. 

 

 



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