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How to Calculate Net Working Capital and What is its Formula? Does it really affect profitability?

Effective management of working capital can help businesses optimize their cash flow, reduce their costs, and improve their profitability. Net working capital measures a company's liquidity and ability to meet short-term obligations.


Net working capital is calculated by subtracting current liabilities from current assets. The formula for net working capital is: Net Working Capital = Current Assets - Current Liabilities


Current assets include cash, accounts receivable, inventory, and other assets that can be easily converted into cash within one year. Current liabilities include accounts payable, accrued expenses, and other short-term liabilities that are due within one year.


Net working capital is an essential measure of a company's financial health because it indicates the capital available to fund daily operations. A positive net working capital indicates that a company has enough current assets to cover its current liabilities. Conversely, a negative net working capital indicates that a company may have difficulty meeting its short-term obligations.


While net working capital is not directly tied to profitability, it can indirectly affect profitability by impacting a company's ability to operate smoothly. A company with a positive net working capital can take advantage of growth opportunities, negotiate better terms with suppliers, and operate flexibly. On the other hand, a company with a negative net working capital may struggle to pay bills on time, miss out on growth opportunities, and operate with greater risk.


In summary, net working capital is a crucial metric for assessing a company's liquidity and financial health. While it may not directly affect profitability, it can impact a company's ability to operate smoothly and take advantage of growth opportunities.

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