What is Operating Working Capital?
Operating working capital is defined asoperating current assets less operating current liabilities. Operating represents assets or liabilities which are used in the day-to-day operations of the business or if they are not interest-bearing (financial). Cash and other financial assets are typically excluded from operating current assets and debt is normally excluded from operating current liabilities.
Operating Working Capital (OWC) = Operating Current Assets – Operating CurrentLiabilities
Key Learning Points
- Working capital is a measure of liquidity and is calculated as current assets less current liabilities
- Operating working capital focuses on the operating short term assets and liabilities required to run a business’s operations and is calculated as operating current assets less operating current liabilities
- Positive OWC indicates cash is tied up in the business’s operations, and short-term funding is required. Negative OWC implies that the company has access to a “free” source of short term funding.
- Although negative OWC is a useful source of cash it may not be appropriate for all businesses. There’s no one ‘right’ OWC level. It depends on the industry.
Cash flow is fundamental for successful businesses and not having cash readily available could result in a loss of opportunities and failure to meet financial obligations. Working capital is current assets less current liabilities and is often expressed as a percentage of sales in order to compare businesses within a sector. The measure attempts to assess the short-term liquidity of a business and determine how well the company can cover the payment of its forthcoming liabilities. It provides an indication of how much cash a business has tied up in current assets and whether it can cover its short-term obligations.
If an industry has inventory that cannot be easily liquidated then often an amended version of the metric is calculated. This uses current assets less inventory instead of current assets and is called the acid test or quick ratio.
Operational Assets
Operational assets are resources used to generate revenues and, therefore, essential for ongoing business operations. Inventories accounts receivable, and prepaid assets are all examples of short-term operational assets. Cash is often excluded as it is seen as a financing item, with its level seen as a choice rather than a necessity to run the business. However, sometimes it may be operational if a business requires cash to operate, such as a travel shop for currency exchange.
Operational Liabilities
Operational liabilities are classified as non-interest-bearing liabilities and result from the operational activities of the business. Accounts payable, salaries payable, and most accrued liabilities are all operational. They are not interest-bearing (in the normal course of business) and, therefore, often referred to as providing “free funding” to the business.
Understanding Operating Working Capital
A business with positive OWC, where short-term operating assets are greater than short-term operating liabilities, requires short-term funding. Cash is “tied up” in the company creating the funding requirement. Businesses with negative OWC, where short-term operating liabilities are greater than short-term operating assets, get extra “free funding”.
Think of a dominant supermarket in your area. In the UK it was Tesco for a long time. Tesco has extraordinary power over its suppliers. It’s such a big buyer and its suppliers are small in comparison. Tesco can demand very generous credit terms from farmers and other suppliers, meanwhile demanding cash from its customers in-store. You can’t buy a loaf of bread on credit. This means big supermarkets often have negative OWC balances, and are using their suppliers as ‘free finance.
Problems with OWC?
You need to be careful when using OWC as an operational measure, as it is very dependent on the industry and how the company operates. Many analysts use the metric to compare two or more businesses of different sizes by representing the number as a percentage of sales. This makes the metric more comparable as the absolute number calculated before only provides just that, a number. The larger the business, the larger the number due to the scale of their operations rather than their efficiency. It is meaningless to compare companies of different sectors due to the difference in the characteristics of the industry.
Example
Operating working capital is calculated using numbers obtained from the balance sheet. Normally, the analyst would also use some footnote details to ensure that the current assets or liabilities in question are truly operational in nature.
The balance sheet numbers for AM Kensington Ltd. are given below. Download the accompanying Excel files to practice calculating operating working capital using these numbers. You can learn more about working capital with The Accountant course
Additional Resources
Working Capital
Accounts Payable
Modeling Ratios
FAQs
Operating working capital is defined as operating current assets less operating current liabilities. Operating represents assets or liabilities which are used in the day-to-day operations of the business or if they are not interest-bearing (financial).
How do you calculate operating working capital financial edge? ›
The formula to calculate operating working capital is equal to the operating current assets subtracted by the operating current liabilities. The table below provides examples of the most common operating current assets and operating current liabilities.
What is OWC working capital? ›
Operating working capital (OWC) refers to a company's current assets used in its day-to-day operations. It's a financial metric to gauge a company's liquidity. It also indicates whether a company can cover its short-term obligations.
What is the difference between OWC and NWC? ›
Operating working capital focuses more on day-to-day operations, whereas net working capital looks at all assets and liabilities. Net working capital is more comprehensive because it represents the cash and other current assets a company has to invest in operating and growing its business.
What is OWC financing? ›
This means the current owner of the home owes no money on the property and becomes the lender for the home's buyer. Owner Will Carry (OWC) loans are an attractive option for those who fail to meet the guidelines for obtaining a loan.
What is the formula for calculating operating capital? ›
Net working capital = current assets (minus cash) - current liabilities (minus debt). Operating working capital = current assets – non-operating current assets. Non-cash working capital = (current assets – cash) – current liabilities.
How do you calculate operating and financial leverage? ›
Meaning of Financial Leverage:
- The formula to calculate the degree of financial Leverage is.
- DFL = % Change in EPS / % Change in EBIT.
- DFL = EBIT/ EBT.
- The formula to compute the degree of operating leverage is.
- DOL = % Change in EBIT / %Change in Sales.
- DOL = Contribution / EBIT.
Change in Working Capital Summary: On the Cash Flow Statement, the Change in Working Capital is defined as Old Working Capital – New Working Capital, where Working Capital = Current Operational Assets – Current Operational Liabilities.
Does OWC include cash? ›
Cash is excluded from Operating Working Capital (OWC) as it is considered a Non-Operating Asset. Whilst cash is a 'Current Asset', the decision to hold cash is not directly related to operations.
What are the three examples of working capital? ›
Working Capital Example: Cash and cash equivalents. To note, Cash equivalents are highly-liquid assets, it includes money-market funds and treasury bills. Funds in checking or in the savings bank account.
Gross Working Capital vs Net Working Capital
Gross working capital is the sum total of all the current assets of a company, whereas net working capital is the difference between the current assets and the current liabilities of a company.
Is higher NWC better? ›
Net working capital refers to the difference between a business's current assets and liabilities. This metric is used to measure the liquidity of a business and indicates short-term financial strength. The higher the net working capital is, the more solvent or liquid the business is.
Is higher or lower NWC better? ›
If a company has very high net working capital, it generally has the financial resources to meet all of its short-term financial obligations. Broadly speaking, the higher a company's working capital is, the more efficiently it functions.
Is tax payable part of operating working capital? ›
Working capital is calculated by subtracting current liabilities from current assets, as listed on the company's balance sheet. Current assets include cash, accounts receivable and inventory. Current liabilities include accounts payable, taxes, wages and interest owed.
What is the difference between working capital and operating expenses? ›
Working capital is the money used to cover all of a company's short-term expenses, including inventory, payments on short-term debt, and day-to-day expenses—called operating expenses.
What is the difference between liquid and working capital? ›
Liquidity refers to a company's ability to meet short-term obligations, while working capital represents the difference between current assets and liabilities. Efficiently managing these financial components ensures smooth operations, risk mitigation, and the ability to seize growth opportunities across all sectors.
Is NWC part of operating cash flow? ›
The Change in Net Working Capital (NWC) section of the cash flow statement tracks the net change in operating assets and operating liabilities across a specified period. If the change in NWC is positive, the company collects and holds onto cash earlier.
What is the difference between free cash flow and net working capital? ›
Working capital is measured by subtracting current liabilities from current assets. Free cash flow is measured by subtracting capital expenditures from your operating cash flow. Both are measurements of your company's financial health, so you want them to be a positive number.
What is the difference between working capital and free cash flow? ›
Working capital offers a snapshot of your company's present ability to pay its most immediate debts, while cash flow projects all income and expenses over a specific period of time. Think of it as a macro and micro level of detail. Cash flow gives you the big picture of your inflows and outflows.
