Net Working Capital: Formula, Calculation, and How to Improve It

What Is Net Working Capital?

Net working capital = Current Assets – Current Liabilities

Current assets are items that can be converted into cash within 12 months, such as cash, accounts receivable, and inventory.

Current liabilities are obligations due within 12 months, such as accounts payable, accrued expenses, and short-term debt.

A positive NWC means your company has enough current assets to cover short-term obligations. A negative NWC signals potential liquidity risk.

How to Calculate Net Working Capital

The basic formula is:

NWC = (Cash + Accounts Receivable + Inventory + Other Current Assets) – (Accounts Payable + Accrued Expenses + Short-Term Debt + Other Current Liabilities)

Example:

Current Assets:

• Cash: $5m
• Accounts Receivable: $20m
• Inventory: $10m
• Other Current Assets: $2m
• Total Current Assets = $37m

Current Liabilities:

• Accounts Payable: $15m
• Accrued Expenses: $8m
• Short-Term Debt: $6m
• Other Current Liabilities: $3m
• Total Current Liabilities = $32m

NWC = $37m – $32m = $5m

This company has positive net working capital of $5 million, meaning it can cover its short-term obligations with room to spare.

What Is Not Included in Net Working Capital?

Not every balance sheet item is part of NWC. By definition, only current assets and current liabilities are included. That means:

• Non-current assets such as property, plant, equipment, goodwill, and intangible assets are excluded.
• Long-term liabilities such as long-term debt, deferred tax liabilities, pension obligations, and lease liabilities beyond 12 months are excluded.
• Cash earmarked for long-term use (restricted cash or investments not available for operations within 12 months) is also excluded.

The goal of NWC is to measure short-term liquidity, so it focuses only on what can be converted into cash within a year and what must be paid within the same time frame.

Why Net Working Capital Matters

NWC is a measure of short-term liquidity and efficiency. It influences:

• Cash Flow: Excess working capital tied up in receivables or inventory can weaken free cash flow.
• Operational Flexibility: Strong NWC allows a business to reinvest in growth without relying on external financing.
• Risk Management: Persistent negative NWC can lead to missed supplier payments, higher borrowing costs, or liquidity crises.

Investors and lenders also pay close attention to NWC as part of financial covenants and creditworthiness assessments.

The Link Between Working Capital, AR, and DSO

The single most common driver of poor NWC is working capital trapped in accounts receivable. When customers take longer to pay, receivables grow, and liquidity shrinks.

This is where Days Sales Outstanding (DSO) becomes critical:

• High DSO = cash tied up in receivables, weaker NWC
• Low DSO = faster collections, stronger NWC

Even companies that are profitable can face liquidity pressure if AR grows faster than revenue.

How to Improve Net Working Capital

• Automate and personalize collection workflows: Send invoices promptly, follow up consistently, and use AI for contextual reminders.
• Improve and enrich your contact information: Flag unresponsive contacts and automatically identify new contact data.
• Resolve disputes faster: Billing disputes are a major source of receivables growth. Have clear escalation processes to resolve them in days, not weeks.
• Manage payables and inventory carefully: While AR is often the biggest lever, efficient inventory and supplier negotiations also strengthen NWC.
• Leverage AI and automation: Modern AR automation tools automate chasing, responses to common queries, prioritize follow-ups, and draft personalized reminders.

The ROI of Improving Working Capital

Reducing DSO is not only about efficiency — it directly releases cash and generates measurable financial returns.

Example: $100M Revenue Company

• Annual Credit Sales: $100,000,000
• DSO Improvement: 30 days
• Cost of Capital: 10%

Daily Credit Sales = $100m ÷ 365 = $273,973

Cash Released = $273,973 × 30 = $8,219,178

Value of Cash Released = $8,219,178 × 10% = $821,918 per year

✅ By improving DSO by 30 days, this company frees up over $8 million in working capital and generates $820k in annual financial benefit, without raising new funds.

This is why CFOs and investors closely track working capital and DSO. Even small improvements can unlock millions in cash and dramatically strengthen free cash flow.

Final Thoughts

Net working capital is a simple formula, but it reveals a lot about a company's liquidity and financial flexibility. Positive NWC gives room to invest and grow, while negative NWC signals stress.

The biggest challenge for most companies is managing accounts receivable. When customers pay late, DSO rises, AR balloons, and free cash flow suffers. By reducing DSO and modernizing collections with automation, companies can strengthen their working capital position and unlock millions in cash.

Want to see how AI can improve your net working capital by reducing DSO? Book a demo with our team.