Operating working capital (OWC) is a financial metric that determines a company’s liquidity and solvency by narrowing the scope of assets and liabilities to inventory, accounts receivable, and accounts payable. It provides a more accurate picture of a company’s operational efficiency and strength.
Operating working capital (OWC) 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 narrowly defines what constitutes those assets and liabilities. In OWC terms, assets are limited to inventory and accounts receivable, while liabilities are limited to accounts payable. By narrowing the scope down to these basic elements, you prevent anything short of the company’s operating success or lack thereof from clouding the financial picture.
When using the simple concept of working capital, the asset portion of the equation includes cash and securities, while liabilities can include any debt a business 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 the concept of operating working capital to be more indicative of how well one company is doing business or how it compares to another in terms of investment opportunities.
To achieve this more accurate financial picture when calculating OWC, assets and liabilities must be separated from the excess numbers that are included in the working capital equation. When calculating a company’s operating assets, all cash amounts must be subtracted from the total assets a company has, leaving only accounts receivable and inventory on that side of the ledger. Similarly, a company’s operating liabilities are calculated by subtracting from its 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 US dollars (USD) in operating assets and $8,000 in operating liabilities. Subtracting the $8,000 from the $10,000 leaves a total of $2,000 in OWC. That means the company would have a $2,000 excess even if it had to pay all of its invoices right away.
The concept of operating working capital is a beneficial measure for newer companies, which often accumulate large amounts of 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 the OWC. This is because a large amount of debt actually reduces the amount of operating liabilities a company has, thus decreasing the amount that is subtracted from operating assets.
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