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Net Working Capital - Meaning, Formula, Examples, Step by Step Calculation - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
of WallStreetmojo friends reveal
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today we are going to learn a concept
that is net working capital formula no
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let's understand what exactly this is
the net working capital formula is the
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total current assets divided by the
total current liabilities now this is
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just the formula again this is a very
important formula for not only for
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the Board of Directors order to be
stakeholders but investors have a really
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a great pinpoint on this particular form
on this particular ratio so why it is
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important let's evaluate let's start
with the basics let's understand the
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formula first and then move to the next
thing in simple terms the net working
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capital denotes the short term you can
say the short term liquidity of the
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company we can do the net capital
calculation simply by adding the current
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assets by and deducting the current
liability let's have a look at the
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formula and try and understand the net
working
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Capital is equal to your total current
assets less your total
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current liabilities okay let's
understand an example on this and we'll
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try and evaluate the things let's say
there's a company called Tally or let's
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say there's a company called Apple lnc
they have some Details like sundry
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sundry creditors
as let's say $45,000
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and they have Sundry Debtors
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has $55,000
we have another item in this that is
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Inventories
which will be close enough to $40,000
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and prepaid salaries
which is let's say $15,000 be final then
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the most final thing that is the
outstanding advertisements which is
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let's say $5,000 so find out the net
working capital of Apple Inc see in the
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above example we have been given the
both the current assets and the current
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liability
we first we need to separate the current
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asset from the current liabilities then
we need the total we need to total up
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the or need to sum up the current assets
and also the current liability and we'll
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get we need to find the difference
between the current assets and current
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liabilities so what does the current
assets include your current asset
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includes your Sundry Debtors your
inventories any prepaid salaries
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okay and in case of current liabilities
it includes your sundry creditors and
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any outstanding advertisement or salary
expenses so let's sum up and find the
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net working capital or let's first find
out the total current assets
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the total current assets assets is going
to be your debtors your inventories and
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your prepaid salaries and your current
liabilities is going to be
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your Sundry Creditors plus any outstanding advertisement expense so your net
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working capital is going to be your
current assets less your current liabilities
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which is $60,000 right
let's make it 50,000 so it's going to be
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$15,000
so the net working capital formula now
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it is quite visible to us we evaluated
with the help of an example let's see
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the net working capital calculation of
Colgate if you see this is the snapshot
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of the Colgate's 2016 and 2015 financial
there are some details of current assets
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4,338 and 4,384 and in case of the current
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liabilities the data is 3,305 and 3,534 so
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if we try and calculate the net working
capital for the same then what you
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receive is something like this the
current assets current liabilities we
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deduct that you get a net working
capital both for 2016 and 2015 now we
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have got the clear idea regarding the
formula let's understand the
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interpretation of the explanation part
of the net care working capital formula
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see nwc is one of the most popular ratio
investors use in this formula there are
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two important elements the first element
that you have
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is the current assets current assets are
those assets that can be liquidated
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within one year or less and that means
the current assets will pay off of will
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pay off for less than your so we can get
we can give an example of current assets
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and such as like daters you have which
is your your accounts receivables then
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you have your inventories any prepaid salaries which we just discussed in the
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previous example the second element of
the same is your current liabilities
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liabilities are those liabilities that
can be paid for less than a year and the
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example of the current liabilities are
Sundry Creditors
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and you have your accounts people
any outstanding rent if any so in this
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formula we'll calculate the difference
between the total current assets and the
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total current liability for networking
capital calculation now what exactly is
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the use of this formula
if you look at the current assets and
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the current liabilities we'll find them
on the balance sheet and the investor
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used the net working capital to know
whether a company is liquid enough to
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pay off its short-term liabilities so
that's why NWC is interpreted properly
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there are two ways through which one can
interpret and can understand that there
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there are two ways you know through
which we can interpret the NWC first is
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when the NWC that is in it
working capital is positive if the
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investor in this case the investor can
understand that the company has enough
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current assets so your current asset is
greater than current liabilities and
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when your nwc is negative
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then in that gives your current asset
will be less than your current
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liabilities that means the investor can
comprehend that the company does not
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have enough assets to pay off its
current liabilities so investor can also
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see the usefulness of the nwc in
calculating the free cash flow to the
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firm and free cash flow to the equity
now remember one thing this two
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component are basically the part of the
DCF calculation the discounted cash flow
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calculation for valuing a company or any
stock so but if there is increase if
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there is an any increase in NWC
it isn't considered as positive remember
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that thing rather it's called as
negative cash flow and obviously this
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increased working capital is not
available for equity now here is your
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net working capital calculator we just
put or punch down any number where let's
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say 20,000 and in your current liability
as 10,000 based on the calculator you
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get your net working capital as 10,000
now let's say it your current assets
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remains 20,000 and if your current
liability goes to 15,000 the net working
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capital formula is 5,000 so based on
this you can try and evaluate your own
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interpretations and come out with some
really useful ideas and which can be
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helpful while evaluating the financial
statements thank you everyone
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