What is the operating working capital of a business? What is its calculation formula? Read to find all the answers.
When managing the accounting affairs of a company, there are many concepts that need to be understood. Accounting forms the backbone of any business, as without sound finances, a company cannot hope to perform well. Out of the many concepts used in evaluating the financial health of a company, one of the most important ones is the operating working capital (OWC). This parameter is also considered when evaluating the balance sheets of a company, that has been public listed.
The working capital is simply the difference between current assets and liabilities of a business. OWC is a variation of the basic concept of working capital. Here, current assets include the accounts receivable, cash reserve of the company, and security investments that can liquidated. The current liabilities include any form of debt and other financial liabilities.
Net OWC is the difference between current assets and liabilities of a business, but here, the assets considered are more limited. To be precise, it is the difference between current assets (with only accounts receivable and current inventory value of the company) and liabilities (which are limited to accounts payable). The calculation does not include cash and securities in the assets and excludes external debt of a company when subtracting the liabilities. A calculation of this value can reveal the solvency and liquidity of a company, according to its day-to-day operations.
It reflects the current performance of the company more clearly than working capital. It determines the amount of cash that remains with the company after subtracting its current accounts payable. So it is used by many financial analysts to determine the current financial health of any business.
How is it Calculated?
Here is the requisite calculation formula.
Operating Working Capital (OWC) = Current Assets (Accounts Receivable + Inventory Value) – Current Liabilities (Accounts Payable)
The current operating assets of a company are USD 100,000, with an operating liability of USD 60,000. Then its OWC is (USD 100,000 – USD 60,000), which amounts to about USD 40,000. It reflects the earnings of the company generated from sales alone, while not including its other assets in the equation.
A company with a strong operating working capital, will be able to sustain short term losses in a better way, than a company, which has a low amount of it. It also helps identify the total cash flow, generated purely from the business operations. A positive change in this capital means that a company is doing better business than before. This makes it an important parameter of consideration. It is a key factor that needs to be calculated, when you are investing in a company and want to ensure its financial soundness.