Gross Working Capital vs Net working Capital
Working capital of a company is one of the most important measures in any financial statement that is also easy to calculate. It is a reflection of the current financial condition of a company that enables investors to know about the health (financial) of a company. However, there are two terms called gross working capital and net working capital that are also used commonly. People remain confused between these two as they cannot differentiate between them. This article will threadbare these two concepts to remove any doubts from those who are interested in the health of a company.
As told earlier, working capital refers to its financial health and is calculated by subtracting its current liabilities from its current assets. If it is positive, it means that the company is in good financial health and can pay its short term debts by selling its current assts. If it is negative, the company cannot meet its debt liabilities even if it sells its current assets such as cash, accounts receivables and inventory. When working capital is in red, it is a signal that company’s operational efficiency is going down or it is not generating enough sales and in the worst possible scenario, negative working capital may result in bankruptcy for a company. As such, working capital is a good indicator for investors to invest or shy away from a company.
Two definitions of working capital are in vogue namely the net working capital and the gross working capital. As such gross working capital is the sum of all current assets of a company, whereas net working capital is the excess of current assets over current liabilities. This clearly implies that it is the net working capital that holds significance for the investors as it tells a lot about a company’s profitability and risk.
Thus it is clear that gross working capital just indicates the capital that a company has invested in current assets. It does not take into account liabilities of the company and as such is not a true indicator of the financial health of a company. On the other hand, net working capital being the difference of current assets and current liabilities reflects operational efficiency and ability to generate more sales.
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In brief: Gross Working Capital vs Net working Capital • Working capital is the liquidity of a company and has two definitions namely gross working capital and net working capital. • Gross working capital is the total of all current assets and does not hold much significance for the investors • Net working capital is the excess of current assets over current liabilities of a company which is why it is an important indicator of company’s financial health.
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