Net working capital

Net working capital is necessary to maintain the financial stability of the enterprise, since the excess of working capital over short-term liabilities means that the enterprise can not only pay off its short-term liabilities, but also has reserves for expanding activities.

The optimal amount of net working capital depends on the characteristics of the company’s activities, in particular on its scale, sales volumes, inventory turnover rate and receivables. The lack of working capital indicates the inability of the company to repay short-term obligations in a timely manner.

A significant excess of net working capital over the optimal need indicates the irrational use of enterprise resources. Of great analytical importance is the consideration of the growth rate of the company’s own working capital against the background of inflation.

Recommended values: > 0

Calculated by the formula: Chok = current assets – current liabilities;

  1. Grouping of assets according to the degree of liquidity. Grouping of balance sheet liabilities according to the terms of securing sources of funds for the enterprise.

The task of analyzing the liquidity of the balance sheet in the course of analyzing the financial condition of an enterprise arises in connection with the need to assess the creditworthiness of an enterprise, that is, its ability to pay off all its obligations in a timely and complete manner, since liquidity is the ability of an enterprise to pay its short-term obligations by realizing its current assets.

Analysis of the liquidity of the balance sheet consists in comparing the funds of the asset, grouped by the degree of their liquidity and arranged in descending order of liquidity, with the liabilities of the liability, grouped by their maturity and arranged in ascending order of maturity.

All assets of the company, depending on the degree of liquidity, i.e., the rate of conversion into cash, can be divided into several groups:

  • The most liquid assets (A 1 ) are the amounts of all cash items that can be used to perform current settlements immediately. This group also includes short-term financial investments.
  • Marketable assets (A 2 ) are assets that require a certain amount of time to turn into cash. This group can include accounts receivable (payments for which are expected within 12 months after the reporting date), other current assets.
  • Slowly realizable assets (A 3 ) – the least liquid assets – these are inventories, receivables (payments for which are expected more than 12 months after the reporting date), value added tax on acquired valuables, while the item “Deferred expenses” is not included to this group.
  • Hard-to-sell assets (A 4 ) are assets that are intended to be used in economic activities for a relatively long period of time. This group includes the articles of section I of the asset balance “Non-current assets”.

The first three groups of assets during the current economic period can constantly change and relate to the current assets of the enterprise, while the current assets are more liquid than the rest of the property of the enterprise.

Liabilities of the balance according to the degree of increase in the maturities of obligations are grouped as follows:

  • The most urgent liabilities (P 1 ) are accounts payable, dividend payments, other short-term liabilities, as well as loans not repaid on time (according to the appendices to the balance sheet).
  • Short-term liabilities (P 2 ) — short-term borrowed loans from banks and other loans that are repayable within 12 months after the reporting date. When determining the first and second groups of liabilities, in order to obtain reliable results, it is necessary to know the time for the fulfillment of all short-term obligations. In practice, this is only possible for internal analytics. With external analysis, due to limited information, this problem becomes much more complicated and is usually solved on the basis of the previous experience of the analyst performing the analysis.
  • Long-term liabilities (P 3 ) – long-term borrowings and other long-term liabilities – items of section IV of the balance sheet “Long-term liabilities”.
  • Permanent liabilities (P 4 ) – items of section III of the balance sheet “Capital and reserves” and separate items of section V of the balance sheet that were not included in the previous groups: “Deferred income” and “Reserves for future expenses”. To maintain the balance of assets and liabilities, the total of this group should be reduced by the amount under the items “Deferred expenses” and “Losses”.

To determine the liquidity of the balance sheet, the totals for each group of assets and liabilities should be compared.

The balance is considered absolutely liquid if the following conditions are met:

A1 >> P1
A2 >> W2
A3 >> W3
A4 << P4

If the first three inequalities are met, that is, current assets exceed the external liabilities of the enterprise, then the last inequality is necessarily fulfilled, which has a deep economic meaning: the enterprise has its own working capital; the minimum condition for financial stability is met.

Non-fulfillment of any of the first three inequalities indicates that the liquidity of the balance to a greater or lesser extent differs from the absolute one.

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