How is net working capital calculated and what does it show?
There is profit on the balance sheet, yet there is no money to pay the supplier. The reason often lies in net working capital. We calculate it from a furniture company's balance sheet.
"Gulbog' Mebel" made a profit all year. Even so, director Botir runs into the same problem at the end of every month: there is not enough money to pay the timber supplier. The finance specialist calculated one figure from his balance sheet and showed it to him: net working capital.
What is net working capital?
It is the difference between the things that will turn into money within the next year and the debts that must be paid within the next year:
Net working capital = Current assets − Current liabilities
Under NAS No. 1, assets expected to be realised or consumed during the normal operating cycle, or expected to be used within 12 months after the reporting date, are current assets, and liabilities to be settled within 12 months from the reporting date are current liabilities. The current assets section of the balance sheet shows inventories, prepaid expenses, the current portion of deferred expenses, receivables, cash, short-term financial investments and other current assets.
If the figure is positive, there is a "cushion" for covering current debts with current assets. If it is negative, the company may need new borrowing or have to sell long-term assets to pay its current debts.
How does it come out on the "Gulbog' Mebel" balance sheet?
Amounts in millions of soum, hypothetical.
| Current assets | Amount | Current liabilities | Amount |
|---|---|---|---|
| Inventories (1010, 2810) | 260 | Payables to suppliers (6010) | 180 |
| Receivables (4010) | 140 | Short-term bank loan (6810) | 120 |
| Cash (5110) | 50 | Payables to the budget (6410) | 30 |
| Prepaid expenses (3190) | 10 | Wages payable (6710) | 20 |
| Total | 460 | Total | 350 |
Calculation: - Net working capital: 460 − 350 = 110 million soum - Current ratio: 460 ÷ 350 = 1.31 - Quick ratio (excluding inventories and prepaid expenses): (460 − 260 − 10) ÷ 350 = 190 ÷ 350 = 0.54
Net working capital is positive, but a large part of it is sitting in the warehouse. Excluding inventories, each 1 soum of current debt is matched by only 54 tiyin of assets that quickly turn into money. That is exactly Botir's problem: the money is "frozen" in timber and finished furniture.
How can the indicator be improved?
| Decision | What changes | New net working capital |
|---|---|---|
| Replace the short-term loan with a long-term one: 5110 / 7810, then 6810 / 5110 | Current liabilities fall by 120 | 460 − 230 = 230 |
| Sell part of the inventories and turn them into money | The structure improves, the amount barely changes | ≈ 110, but the quick ratio rises |
| Buy equipment with current funds (40 million) | A current asset becomes a long-term asset | 420 − 350 = 70 |
The first row comes with one warning: the part of a long-term loan payable within the next 12 months is transferred to 6950 "Long-term liabilities – current portion" (7810 / 6950). In other words, the problem does not disappear completely; you only gain time.
The third row is instructive too: the equipment is useful, but buying it out of monthly working funds reduces the ability to pay current debts.
Test yourself
5 questions on this topic: pick an option or reveal the answer.
The balance sheet of the "Qo'qon qog'oz" wholesale firm shows: current assets 260 mln soum, current liabilities 190 mln soum, long-term liabilities 80 mln soum. What is net working capital (current assets − current liabilities)?
In its initial issue, "Ko'hitang" joint-stock company placed 2 000 ordinary shares with a face value of 5 000 soum at 6 500 soum each; the money was received in the settlement account. What is the excess over face value (additional paid-in capital), and with what journal entry is it recorded under NAS No. 21?
A company's total liabilities are 400 mln soums and its equity is 500 mln soums. What is the debt-to-equity ratio (liabilities / equity)?
"Navbahor tekstil" JSC split its shares: for each ordinary share with a nominal value of 10 000 soum, 5 new shares with a nominal value of 2 000 soum each were issued, and the charter capital amount did not change. How is this transaction recorded under NAS No. 21?
The annual net revenue of "Chilonzor qandolat" LLC is 730 mln soums. Receivables were 50 mln soums at the beginning of the year and 70 mln soums at the end. What is the average collection period of receivables (average receivables / revenue × 365) in days?
Answered: 0 / 50 of 5 correct
All tests →See also
Sources
- NAS No. 1 "Presentation of Financial Statements and Accounting Policies", paragraphs 65, 66, 68 and 73 · criteria for current assets (operating cycle or 12 months after the reporting date) and their composition; liabilities to be settled within 12 months are current liabilities
- NAS No. 21 "Chart of Accounts", paragraphs 292, 332 and 336 · 6810 short-term bank loans; 7810 long-term bank loans; current portion of a long-term loan 7810 / 6950
- Example, amounts and ratio calculations · prepared by the author, hypothetical