What is Net Working Capital (NWC) Flow?

Finance ManagementBanking & FinanceGrowth & Empowerment

The working capital flow occurs when there is a net increase or decrease in working capital due to a transaction. There are some transactions involved in a firm’s projects that change working capital. Whereas, there are other transactions that have no net effect on the working capital.

Usually, items from profit and loss accounts and business events that affect current and non-current accounts simultaneously effect the net working capital flow of a company. There are also current-only and non-current-only accounts the changes in which do not affect the net-working capital flow.

Increase and Decrease in Working Capital

Following are some examples to understand the concept of NWC −

Example 1 − Suppose a company issues shares in the capital market. The net effect of this will be in the company’s cash account which is a current (asset) account, and also in the share capital account which is a non-current account. The company gets cash in the transactions against the ownership claims of the investors. So, there is a net increase in working capital in this situation.

Example 2 − When the company buys machinery paying cash, there are two effects that are generated. The company’s cash or current (asset) account and the machinery account which is a non-current asset account are affected. The net effect is a decrease in the working capital inflow in such a condition.

No Change in NWC if Both Accounts Are Current Accounts

  • Suppose a company raises cash from debtors. It will increase the cash which is a current (asset) account and decrease the debtors which is also a current asset account. So, there is no net working capital flow change in the transactions. This will however change the composition of capital inflow patterns.

  • When the company pays the cash back to creditors, there are two items that are affected. The first is the cash or the current asset account which decreases, and the second is the creditor's account which is a current liability account that also decreases due to the transactions. The net effect will have no net change in working capital although the composition of working capital changes.

No Change in NWC if Both Accounts Are Non-Current Accounts

In some cases, the working capital flow is not affected when the two accounts associated are non-current in nature.

  • For example, if a company pays for land it has bought by shares, there will be no net change in the working capital. In this case, both accounts are non-current in nature and there is, therefore, no net change in working capital in this case.

  • When a company converts loans and debentures into equity, no net change in working capital takes place.

In the Profit and Loss accounts, the cash receivables that are increased by revenue items, increase the working capital. On the other hand, the expense items that increase current liability or cash decrease working capital.

It must be noted that there are some items in the profit and loss accounts that are non-current in nature and so they do not alter working capital. For example, depreciation is non-current in nature. Depreciation decreases fixed assets but does not change the working capital.

Conclusion

It may be noted that for a change in net working capital one item in the transaction should be current and another account must be non-current.

Moreover, it may be summarized as follows −

  • For a change in the net working capital, there should be two accounts of opposite nature - current and non-current.

  • Net working capital remains unchanged when both accounts related are current accounts.

  • Net working capital also remains unchanged when the related two accounts are non-current.

raja
Updated on 15-Apr-2022 11:46:33

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