Net Working Capital
AdvancedNet working capital is the difference between a business's current operating assets, such as receivables and inventory, and its current operating liabilities, such as payables, usually excluding cash and debt when used in valuation and modelling.
In general accounting, working capital is current assets minus current liabilities. In valuation, financial modelling and acquisitions, net working capital usually refers to a narrower, operating version that excludes cash, short-term investments and short-term borrowings, since these relate to financing rather than day-to-day operations.
For example, a business with receivables of 300,000 and inventory of 200,000, and payables of 250,000, has net working capital of 250,000.
Changes in net working capital affect cash flow. When a business grows, it usually needs more receivables and inventory, absorbing cash. In a discounted cash flow model, an increase in net working capital is subtracted from free cash flow.
In acquisitions, buyers and sellers often agree a normal level of net working capital, called a peg, and adjust the price if the actual level at completion is higher or lower. Definitions vary between deals and analysts, so the items included should be checked carefully.
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