In this guide, we’ll explore what net working capital is, how to calculate it, and its relevance to your everyday operations. We’ll also share insights to help you improve your working capital and explore funding options.
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We’re willing to bet that as a small business owner, you spend a significant proportion of your time thinking about cash flow and finances. Understanding net working capital (NWC) is a vital part of keeping your business financially healthy and ensuring its sustainability.
NWC measures a business’s short-term financial health and ability to cover day-to-day expenses. It is calculated as the difference between current assets and current liabilities.
The formula for NWC is quite simple: It’s current assets - current liabilities.
If your business has £100,000 in current assets and £70,000 in current liabilities, you can calculate your NWC like this:
£100,000 - £70,000 = £30,000
A positive NWC indicates that your business has sufficient resources to cover short-term obligations, while a negative NWC suggests potential liquidity issues.
Understanding your NWC helps you make informed decisions about your business operations and growth strategies. Here’s why it’s important:
A positive NWC figure indicates that your current assets exceed your current liabilities. This surplus lets you handle immediate financial needs quickly and easily, such as paying suppliers on time.
It also means you can pay your people on time. Naturally, this will keep employees motivated and operations running smoothly.
A positive NWC also gives a buffer against unexpected expenses or economic downturns, allowing you to navigate challenges without resorting to emergency financing.
Keeping tabs on your NWC helps you assess whether your current assets are sufficient to cover short-term liabilities, providing an early warning system for potential cash flow gaps.
By spotting these risks early, you can take action to mitigate problems quickly, such as chasing up receivables, adjusting inventory levels, or securing short-term financing.
Zooming out, NWC trends also offer valuable insights into your business’s efficiency in managing resources and meeting financial obligations.
3. Growth opportunities
With sufficient NWC, your business can fund key activities like purchasing new equipment, hiring more people, or launching new products directly from available resources.
This reduces dependence on external financing, minimising debt and interest costs. By enabling self-funded expansion, adequate NWC strengthens your business’s financial independence and fosters sustainable growth.
Understanding how your NWC changes over time is essential for cash flow management and financial planning. To calculate the change in NWC:
Change in NWC = NWC (current period) - NWC (previous period)
There’s a bit of nuance here: An increase or decrease in NWC isn't always good or bad—it depends on the reasons behind it and your business's needs. We’ll look at this in more detail in the next section.
When NWC increases:
It might seem like good news because it shows your business has more resources than short-term debts. Indeed, sometimes it is simply that: Good news.
However, it could also mean too much of your money is stuck in things like unsold products (inventory) or waiting for customers to pay their invoices (receivables). This ties up cash that you could use elsewhere.
When NWC decreases:
Similarly (and perhaps slightly counter-intuitively), a decrease in NWC may actually be a positive indicator.
It could mean, for example, you're using your cash more efficiently, like reducing inventory or speeding up payments from customers. The caveat is that if your NWC goes too low, it could mean you’re struggling to pay your bills or don’t have enough cushion for unexpected expenses.
Almost half of small businesses globally (40%) have three months or less of cash to sustain their operations. Getting beyond this means improving your business’s NWC. NWC is crucial for maintaining liquidity and funding growth.
Here are practical strategies you can use to improve NWC:
A working capital loan is a short-term finance solution designed to help you when cash flow fluctuates, and is used to pay for short-term needs like payroll, rent, or inventory.
Working capital loans are particularly useful if you have a seasonal business, experience uneven cash flows or frequently face late-payments (UK SMEs are owed approximately £22,000 annually in late payments, according to the UK government).
These loans can come in various forms, including traditional bank loans, invoice financing, and trade credit. Interest rates and terms depend on factors such as the lender, your credit score, and the loan’s structure.
An alternative to these more traditional loan products is our Flexi-Loan,
When you get approved for a Flexi-Loan, we’ll give you a credit limit, which you can then transfer from the loan to your bank account as you need it. You’re only charged interest on the amount you actually draw down and you can repay at any time with no extra charges.
Learn more about working capital loans and how they can support your business.
Negative NWC means your current liabilities exceed current assets, potentially indicating cash flow issues. However, its significance depends on your industry and operating cycle.
Subtract the NWC of the previous period from the current period. A positive result indicates an increase, while a negative result shows a decrease.
To project NWC, analyse historical trends in your current assets and liabilities. Adjust for anticipated changes, such as increased sales or seasonal variations.
Changes in NWC influence the cash available for reinvestment or distribution. A decrease in NWC generally increases free cash flow, while an increase reduces it.
