Net working capital (NWC) is a measure of a company’s operational efficiency, and answering the question “how many NWC should a company have” is not possible to answer “as much as possible.” NWC is the difference between current assets, including cash, accounts receivables, and others, and current liabilities such as debts and accounts payable (Boisjoly et al., 2018). A ratio lower than 1.0 indicates that a company’s assets do not cover obligations. For instance, a company rents a warehouse that is much bigger and more expensive than the one that would cover their needs, which reduces the business liquidity. The NWC ratio higher than 2 is also interpreted as negative because it implies that a company does not use free cash effectively (Behlje & Langemeier, 2020; Motley Fool Staff, 2016). For instance, the quantity of products company manufacture is lower than the market’s demand because an owner does not consider investing in more effective equipment. Therefore, it is essential to determine the optimal NWC that should lie between 1.0 and 2.0.
The student provides a convincing explanation for the concept of working capital showing its application based on the example of a lumber yard’s operation. It is justified that it is not beneficial for the enterprise to have too much or too little assets compared to liabilities as it cannot afford shipments of products or its goods remain unsold. However, there is no solid determination of the NWC as a dependency between assets and liabilities. Moreover, it is not stated what ratio is considered “good” and what is rather “bad” for an organization. Thus, Boisjoly et al. (2018) provide calculations of NWC, which can be used to determine the range of effective value of this ratio that can be an essential complement to this post. Despite a solid presentation of examples, the post lacks key points of the concept.
References
Behlje, M., & Langemeier, M. (2020). Working Capital: What is it and do uou have enough?Purdue.edu.
Boisjoly, R. P., Conine, T. E., & McDonald M. B. (2020). Working capital management: Financial and valuation impacts. Journal of Business Research, 108, 1–8.
Motley Fool Staff. (2016). What is Working Capital?Fool.com.