Operating Working Capital

When managing the accounting affairs of a company, there are many concepts that need to 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.

Working capital is simply the difference between current assets and liabilities. 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.

Definition

The net OWC is a difference between the current assets and current liability of the company, but here the assets considered are more limited. It is the difference between the 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. It is the total sales of the company divided by its OWC value. 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 Operating Working Capital 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 $100,000, with an operating liability of $60,000. Then its OWC is ($100,000 - $60,000), which amounts to about $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 better than a company, which has a low OWC. It also helps identify the total cash flow, generated purely from the business operations. A positive change in operating working capital means that a company is doing better business than before. This makes it an important parameter of consideration. It is a key parameter, that needs to be calculated when you are investing in a company and want to ensure its financial soundness.