Net Working Capital
What It Means
Net Working Capital simply refers to the difference between a company’s Current Assets and Current Liabilities.
Current Assets include cash, cash equivalents, and all other assets that are expected to be converted into cash over the next year, such as Accounts Receivable and inventory.
Current Liabilities include all financial obligations that are due over the next year, such as Accounts Payable, credit cards, and short term loans.
Why It’s Important
Generally, Net Working Capital represents a company’s ability to meet its short term debt obligations. However, it is also a good indicator of the cash demands of a business. The more Net Working Capital a company requires in the normal course of operation, the more cash will be required to fuel growth.
Oftentimes, Letters of Intent and similar Acquisition documents will include a provision to make an adjustment to Enterprise Valuation at closing to account for changes in Net Working Capital. These adjustments could lead to an increase or decrease in Enterprise Value and are intended to account for recent changes in the company’s financial position.