What is operating working capital?

Operating working capital is a financial metric designed to accurately determine a company's liquidity and solvency. It is similar to the basic concept of working capital in that it is calculated by subtracting a company's liabilities from its assets, but more strictly defines what constitutes those assets and liabilities. In terms of operating working capital, or OWC, assets are limited to inventory and accounts receivable, while liabilities are limited to accounts receivable. By narrowing the scope to these fundamentals, you prevent anything but the company's operational success or lack thereof from clouding the financial picture.

When using the simple concept of working capital, the assets part of the equation includes cash and bonds, while liabilities can include any debt a company has accumulated. However, these numbers are more a reflection of a company's financial structure than a true measure of its operational efficiency or day-to-day business strength. As a result, financial experts can trust that the concept of operating working capital is more indicative of how well a company is doing business or how it stacks up against another in terms of investment opportunities.

To get this more accurate financial picture when calculating operating working capital, assets and liabilities must be separated from the excess numbers included in the working capital equation. When calculating a company's operating assets, all cash values ​​must be subtracted from the total assets a company owns, leaving only accounts receivable and inventory on that side of the ledger. Similarly, a company's operating liabilities are calculated by subtracting from the total liabilities any short-term debt the company may have.

Once these adjustments are made, it is relatively easy to determine the operating working capital of the business in question. For example, Company A has $10,000 in operating assets and $8,000 in operating liabilities. Subtracting the $8,000 USD from the $10,000 USD leaves a total of $2,000 USD in OWC. This means that the company would have a surplus of $2,000 even if it had to pay all of its bills immediately.

The concept of operating working capital is a beneficial measure for newer companies, which often accumulate large short-term debt in an attempt to get the business off the ground. Short-term debt actually works in a company's favor when calculating OWC. This is because a large amount of debt actually reduces the amount of operating liabilities a company has, thus decreasing the value that is subtracted from operating assets.

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