How Working Capital Impacts Financial Viability

What net working capital is and why it matters

Net working capital (NWC), also known as working capital or the "fondo de maniobra" in Spanish practice, represents a company's capacity to meet its short-term obligations using its current assets. This indicator is essential for financial analysts and CFOs, because it makes it possible to assess operational solvency, anticipate liquidity crises and plan business growth. This article analyses its definition, components, calculation, sector-specific interpretation, relevance in financial transactions and optimisation strategies, including cases where negative net working capital is perfectly compatible with financial health.

It is calculated as the difference between current assets and current liabilities. In simple terms, it represents the resources available to finance day-to-day operations and immediate obligations. Adequate net working capital ensures that the company can operate normally and meet its payments on time, avoiding liquidity problems that could jeopardise the continuity of the business.

Managing that operating liquidity well is one of the core functions of a fractional CFO.

How net working capital is calculated

Net working capital formula:

Net working capital (NWC) is defined as the difference between current assets and current liabilities:

NWC = Current Assets - Current Liabilities

Current assets include resources expected to be converted into cash within 12 months, such as cash at bank and in hand, trade receivables, inventories and other items such as prepayments. Current liabilities, for their part, include debts that must be paid within the same period, such as trade payables, short-term bank loans and immediate tax or employment obligations.

Positive net working capital indicates that the company has its own resources to operate without depending on short-term external financing. Negative NWC, by contrast, suggests that current liabilities exceed current assets, which can be worrying in sectors that require a permanent liquidity base. However, as we shall see, there are industries in which operating with negative net working capital is not only common but part of an efficient model.

• Current assets: cash, inventories, receivables, liquid investments.
• Current liabilities: payables, short-term debt, other immediate obligations.

Worked example

Suppose a company has current assets of €400,000 and current liabilities of €250,000.

Net working capital = €400,000 - €250,000 = €150,000

This means the company has €150,000 available to cover its immediate obligations.

Net working capital vs working capital

Although the terms "net working capital" and "working capital" are often used interchangeably, there are nuances:

• Net working capital: a more accounting-based approach, focused on the difference between current assets and current liabilities.
• Working capital: a more financial approach, which includes the operational management of inventory, receivables and payables.

We go deeper into that distinction and into working capital management in our article on what working capital is and why it matters.

In practice, it is worth distinguishing between accounting net working capital and operating working capital. While the former is a simple accounting difference between current assets and liabilities, the latter excludes cash and short-term financial debt to focus on the operating components: receivables, inventories and payables.

This distinction allows the analyst to focus on the capital directly involved in the operation. For example, if a company holds a lot of cash from an extraordinary sale or a debt issue, accounting NWC may look robust even though operating activity is under strain. That is why, when analysing operational health, it is advisable to look at operating working capital, which shows whether the company needs additional liquidity to sustain its production, sales and collection cycles.

How to interpret net working capital in your company

Interpreting net working capital correctly helps you take better financial decisions.

What it means when it is positive, negative or zero

• Positive: the company has sufficient liquid resources to cover its immediate obligations, which supports operational stability.
• Negative: indicates potential liquidity problems, since liquid assets do not cover immediate obligations.
• Zero: current assets exactly cover immediate obligations, indicating a tight and potentially risky situation.

The main risk of negative NWC lies in the lack of margin to absorb deviations from the financial plan: customer defaults, delayed sales or increases in inventory can quickly put liquidity under strain. It is therefore advisable to assess NWC together with other indicators such as operating cash flow, inventory turnover and the behaviour of the cash conversion cycle.

Factors that affect the result

The interpretation of net working capital must be qualified by industry. In manufacturing sectors, it is usual to maintain positive NWC, since the company needs to finance inventory and extend trade credit to its customers. A machinery manufacturer, for example, may have projects that take weeks or months to complete and collect, which requires a working capital base financed with permanent resources.

By contrast, in retail distribution, such as supermarkets or hypermarkets, NWC can be structurally negative without this being a problem. This is because sales are collected in cash (cash or card) and payments to suppliers are deferred for 60 or even 90 days. This gap allows the company to operate with current liabilities financing a large part of its working capital. Mercadona, for example, collects at the till every day while negotiating extended terms with suppliers, generating a source of financing with no financial cost.

The technology sector, especially SaaS companies, also has its particularities. Subscriptions collected in advance are recorded for accounting purposes as a current liability (deferred revenue), even though the cash is already in the bank. This can produce negative accounting NWC despite a comfortable cash position.

Insurers, for their part, also present a unique profile: they collect premiums in advance but must make provisions for future claims. Although current liabilities are high, they operate with significant levels of cash.

Negative net working capital should not automatically be read as a sign of illiquidity. As we have seen, in sectors such as retail or SaaS it can be part of an efficient strategy. However, in companies that are intensive in current assets, such as manufacturing or agriculture, sustained negative NWC usually indicates excessive dependence on short-term credit. In short, the adequacy of NWC cannot be assessed without considering the business model.

Net working capital is particularly sensitive in phases of rapid growth.

When a company multiplies its sales, its inventory and receivables requirements also increase, generating greater investment in working capital. If this growth is not accompanied by adequate financing, a liquidity crisis can arise despite accounting profitability. It is the classic case of "dying of success": to sustain that growth, it is advisable to anticipate requirements with a rolling forecast and, where appropriate, secure financing lines in time.

During economic crises or recessions, NWC is also affected. Defaults increase, sales fall and inventories build up. Companies with reduced NWC have less room for manoeuvre to withstand these pressures. In this context, planning and continuous monitoring become essential. When the strain leads to an unsustainable debt structure, the route is a debt restructuring or refinancing.

Finally, in high-interest-rate environments, financing working capital becomes more expensive. Companies that depend on credit lines to sustain their operations must review their net working capital strategy. Optimising the use of own resources, releasing cash from working capital and renegotiating terms become a priority to avoid excessive financial costs.

Tips for improving net working capital

Efficient management of net working capital makes it possible to release tied-up resources and reduce the need for external financing.

The main lines of action include improving collections management, by shortening credit terms, controlling commercial risk and using instruments such as factoring to bring liquidity forward.

On the payments side, it is key to negotiate terms with suppliers that allow payment periods to be extended without damaging the commercial relationship. Intelligent use of bargaining power can turn current liabilities into a cost-free source of financing.

Inventory management is also decisive. Methods such as just-in-time, combined with good demand planning, correctly sized stock and a well-adjusted product range, together with analysis of stock turnover by reference, control of obsolescence and elimination of obsolete stock, can significantly reduce the investment needed in inventories.

Finally, having an active treasury function and cash-forecasting tools makes it possible to anticipate needs and avoid last-minute, more expensive financing.

Relevance of NWC in M&A and business valuation:

In mergers and acquisitions, the level of net working capital is a matter of negotiation. The buyer usually demands a normalised level of working capital that ensures operational continuity after the transaction. If NWC is below the expected threshold, the purchase price is adjusted or the seller is required to inject additional capital. That normalised level (the "peg") and its impact on price is one of the key points of any company sale or M&A process.

During financial due diligence, the historical evolution of net working capital, its seasonality and its relationship with revenue are analysed. This makes it possible to detect deviations or extraordinary requirements. We explain how this is analysed in practice when comparing due diligence with a financial audit. In valuation models such as discounted cash flow (DCF), investments in working capital are deducted from future cash flows. Growth with greater working capital requirements reduces the net present value of the business. Indeed, NWC forms part of the bridge between enterprise value and the price to the shareholder, as we see in Enterprise Value vs Equity Value.

Related ratios:

To complement the analysis of net working capital, there are specific ratios that refine the reading. The most widely used is the current ratio, which relates current assets to current liabilities. A value above 1.2 is usually considered healthy, although it must be qualified by sector.

Another relevant indicator is the acid test or quick ratio, which excludes inventories from current assets. In this way, immediate liquidity is measured without counting assets that are less readily realisable. It is especially useful in sectors with slow turnover or risky inventory.

Finally, the cash conversion cycle makes it possible to understand how many days elapse between paying suppliers and collecting from customers, via the sale of inventory. The formula combines days of inventory, days of receivables and days of payables. The shorter the cycle, the better the financial efficiency. A negative cycle, as in companies such as Amazon, reflects a significant competitive advantage.

External financial support and planning

Net working capital is much more than an accounting indicator: it is a diagnostic tool, a management lever and a key factor in strategic decisions. For CFOs and financial analysts, understanding its behaviour, optimising its structure and anticipating its requirements is essential to guaranteeing financial viability in the short and medium term. In models such as retail, its value can be negative without risk; in others, such as manufacturing, it must be kept positive. In any case, rigorous management improves liquidity, strengthens the position before lenders and raises the value of the company.

Crucial moments such as expansions, mergers, acquisitions or fundraising are situations where solid net working capital can make the difference between financial success and failure.

Having specialised financial advisory or bringing in a fractional CFO can be an effective solution for companies that need to improve their net working capital quickly. These professionals can implement efficient systems and strategies, optimising the financial and operating structure.

Javier de Rojas Roca de Togores

Partner - Maraz Corporate Finance

Frequently asked questions about net working capital

Is net working capital the same as working capital?

They are used almost as synonyms, but there are nuances: net working capital has a more accounting-based approach (current assets less current liabilities) and working capital, a more operational one (management of inventory, collections and payments). We develop this in what is working capital.

Is negative net working capital always bad?

No. In sectors such as retail (supermarkets) or SaaS, negative NWC is common and even efficient, because they collect in cash or in advance and pay suppliers on terms, financing themselves for free through working capital. By contrast, in manufacturing or agriculture, sustained negative NWC usually does indicate excessive dependence on short-term credit. It depends on the business model.

How does net working capital affect the sale of a company?

A great deal. In an M&A transaction, the buyer demands a "normalised" level of working capital; if it is below that, the price is adjusted. During due diligence, its historical evolution and seasonality are analysed. And in a DCF valuation, higher working capital requirements reduce the value of the business.

Which ratios complement the analysis of net working capital?

Three main ones: the current ratio (current assets / current liabilities, healthy above 1.2 depending on the sector), the acid test or quick ratio (which excludes inventories to measure the most immediate liquidity) and the cash conversion cycle (days between paying suppliers and collecting from customers). The shorter the cycle, the better; a negative cycle, like Amazon's, is a competitive advantage.

Why can a growing company have net working capital problems?

Because growing consumes cash: more sales require more inventory and more customer credit, increasing the investment in working capital. If it is not financed in time, there can be a liquidity crisis despite being profitable ("dying of success"). Anticipating it with a rolling forecast and a fractional CFO diagnosis is the best prevention.