Net working capital (NWC) is current assets minus current liabilities — the dollar cushion a company has for paying its bills over the next twelve months. If current assets are $96,500 and current liabilities are $52,400, net working capital is $44,100. Analysts often use an operating variant that excludes cash and short-term debt, because those lines reflect financing choices rather than the day-to-day business.
You need this formula in two situations, and they ask different questions. On a homework problem about liquidity, you compute the level of NWC from a single balance sheet. In a valuation or cash-flow problem, you compute the change in NWC between two balance sheets, because that change is what absorbs or releases cash. This page works through both.
Net working capital (NWC) = Current assets − Current liabilities
Current assets — Assets expected to become cash within a year: cash, accounts receivable, inventory, prepaid expenses
Current liabilities — Obligations due within a year: accounts payable, accrued expenses, short-term debt
The basic form is what most textbooks mean by the net working capital formula, and it is the one to use unless a problem says otherwise. But analysts building cash-flow models usually strip two items out. Cash itself is not tied up in operations — a company chooses how much cash to hold, and a big cash balance would make NWC look large without telling you anything about the business. Short-term debt is a financing decision: borrowing $15,000 from a bank changes how the company is funded, not how much cash its receivables and inventory soak up. Removing both leaves only the operating lines, which is why the variant is called operating working capital. It measures how many dollars the business model itself keeps tied up between paying suppliers and collecting from customers.
Operating NWC = (Current assets − Cash) − (Current liabilities − Short-term debt)
Cash — Cash and cash equivalents, including marketable securities held as a cash substitute
Short-term debt — Notes payable and the current portion of long-term debt — financing items, not operating ones
Every number in the formula sits on the balance sheet, in the two sections labeled current. Current assets are listed in order of liquidity: cash first, then accounts receivable (what customers owe), inventory (goods waiting to be sold), and prepaid expenses (bills paid in advance, like insurance). Current liabilities follow the same logic: accounts payable (what the company owes suppliers), accrued expenses (wages and taxes earned but not yet paid), and any debt due within a year. If reading those sections still feels shaky, how a balance sheet fits together walks through each line.
One relative worth knowing: divide the same two totals instead of subtracting them and you get the current ratio. NWC is the dollar form of that exact comparison — $44,100 of cushion — while the ratio form scales it, so you can compare a small firm to a large one.
| Line item | Year 1 | Year 2 |
|---|---|---|
| Cash | $18,300 | $12,900 |
| Accounts receivable | $42,700 | $51,200 |
| Inventory | $31,400 | $38,600 |
| Prepaid expenses | $4,100 | $4,700 |
| Total current assets | $96,500 | $107,400 |
| Accounts payable | $27,600 | $30,100 |
| Accrued expenses | $9,800 | $10,400 |
| Short-term debt | $15,000 | $15,000 |
| Total current liabilities | $52,400 | $55,500 |
Start with Year 1. Basic NWC is total current assets minus total current liabilities: $96,500 − $52,400 = $44,100. For the operating variant, remove cash from the assets ($96,500 − $18,300 = $78,200) and short-term debt from the liabilities ($52,400 − $15,000 = $37,400), then subtract: $78,200 − $37,400 = $40,800.
Now Year 2, same steps. Basic NWC: $107,400 − $55,500 = $51,900. Operating NWC: ($107,400 − $12,900) − ($55,500 − $15,000) = $94,500 − $40,500 = $54,000.
Both variants are positive in both years, so Marlow has a cushion either way you measure it. The interesting part is what happened between the two years.
A growing company sells more, so receivables and inventory grow with it — and every extra dollar sitting in receivables or on a warehouse shelf is a dollar the company spent but has not collected yet. Growth eats cash through working capital, even when the income statement shows a healthy profit. That is why cash-flow analysis cares about the change in NWC, not the level: when NWC rises, the increase came out of cash, and when NWC falls, cash was released. This is the same adjustment the indirect method makes on the statement of cash flows, and in a DCF it appears as a subtraction — free cash flow deducts the increase in NWC before anything reaches investors.
The change is computed the way you would expect: this year's NWC minus last year's, using the same variant both years.
| Measure | Year 1 | Year 2 | Change | Cash effect |
|---|---|---|---|---|
| Basic NWC | $44,100 | $51,900 | +$7,800 | $7,800 absorbed |
| Operating NWC | $40,800 | $54,000 | +$13,200 | $13,200 absorbed |
Recompute each change. Basic: $51,900 − $44,100 = +$7,800. Operating: $54,000 − $40,800 = +$13,200. Marlow's working capital absorbed cash this year — $13,200 of it on the operating measure, which is the one a free-cash-flow model would subtract.
Why do the two changes disagree? Look at where the operating build-up came from. Receivables rose $8,500 ($51,200 − $42,700), inventory rose $7,200 ($38,600 − $31,400), and prepaid expenses rose $600, so operating assets grew $16,300. Payables rose $2,500 and accrued expenses rose $600, so operating liabilities grew only $3,100. The net operating build-up is $16,300 − $3,100 = $13,200 — cash spent on inventory and cash still stuck in customers' hands. The basic measure hides part of this, because Marlow's cash balance fell $5,400 ($18,300 − $12,900), and that fall shrinks basic current assets: $13,200 − $5,400 = $7,800. The cash drain is real either way; the operating variant just refuses to let the shrinking cash balance mask it. That is exactly why analysts prefer it.
A company with more current liabilities than current assets has negative NWC, and exam answers often mark that as distress by reflex. Sometimes it is. But subscription businesses and fast-turning retailers collect cash from customers before they pay suppliers — a grocery chain sells the inventory weeks before its payables come due. For those models, negative NWC means suppliers and customers are financing the operations, which is a strength. Negative NWC is a problem when it comes from slow collections or a company that cannot roll over its payables, not when it comes from a favorable cash cycle.
A change in NWC only means something if both years use the same definition. Computing basic NWC for Year 1 and operating NWC for Year 2 produces a number ($54,000 − $44,100 = $9,900 here) that measures nothing. Homework problems usually want the basic form; valuation problems want the operating form. Pick one, state it, and use it for every period.
Marlow's NWC went up, and a rising cushion sounds healthy. But if the question is about cash flow, up is the expensive direction — the company put $13,200 into working capital that it cannot spend on anything else. Read the question carefully: liquidity questions want the level, cash-flow and DCF questions want the change, with its sign.
Net working capital = current assets − current liabilities: the dollar cushion for the next year. For cash-flow questions, use the change instead — when NWC rises, the increase came straight out of cash.
Net working capital is current assets minus current liabilities — the dollars a company would have left after paying everything due within a year using only assets that convert to cash within a year. A positive figure is a liquidity cushion; a negative one means short-term obligations exceed short-term resources, which may or may not be a problem depending on the business model.
Take total current assets and total current liabilities from the balance sheet and subtract: NWC = current assets − current liabilities. With current assets of $96,500 and current liabilities of $52,400, NWC is $44,100. For the operating variant, remove cash from the assets and short-term debt from the liabilities before subtracting.
Compute NWC for two consecutive periods using the same definition, then subtract: change in NWC = this period's NWC − last period's NWC. A positive change means working capital absorbed cash during the period; a negative change means it released cash. Free-cash-flow models subtract an increase in NWC.
Yes. When receivables and inventory grow faster than payables, the company has spent or committed cash it has not collected back, so an increase in NWC is subtracted when computing free cash flow. A decrease works the other way — it releases cash.
Not automatically. Businesses that collect from customers before paying suppliers — subscriptions, many retailers — run negative NWC by design, and it works as free financing. It is a warning sign when it comes from slow collections, aging inventory, or a company struggling to refinance short-term debt.
They compare the same two totals. NWC subtracts them (current assets − current liabilities) and gives a dollar amount; the current ratio divides them and gives a scale-free multiple. Use dollars for cash-flow work and the ratio for comparing companies of different sizes.
By the FinanceBrain Team · Last verified July 11, 2026 · How we produce and verify articles