Operating working capital (OWC) refers to a company’s current assets used in its day-to-day operations. It’s a metric to gauge the short-term liquidity of a business.
It shows how much capital a business has in the form of current assets. It also indicates whether a company can cover its short-term obligations.
When a business has a high operating working capital, it may mean all or most of its capital is tied up in day-to-day operations. In this instance, a company would need more capital if it wants to expand its operations to offer more products.
In business, there’s a lot of talk about cash flow because it’s critical in growing a successful company. For instance, a business with readily available cash can jump at profitable opportunities when they arise. But a company strapped for cash may not be able to pay its rent and other obligations.
This article explains what OWC is used for, how to calculate it, and how working capital loans work.
How Is Operating Working Capital Used?
Operating working capital refers to a business’s capital that’s already tied up in its operations. Operating expenses include employees’ salaries and wages, raw materials and supplies, inventory, utilities, and rent.
Operating working capital shows how efficiently a company uses and manages its funds. It reveals how much cash a business has.
When a business has high operating working capital, it may mean that it has exhausted its capital to fund its operating cycle. If the company wants to expand its operations, such as buy new equipment or rent a bigger space to meet the demand of peak seasons, it will need more funding.
Understanding how working capital works is critical because it affects many aspects of your business. Working capital keeps your company operating smoothly to meet its financial obligations.
The Formula for Operating Working Capital
The formula for operating working capital is:
Operating Working Capital = Current Operating Assets – Current Operating Liabilities
Cash and cash equivalents are typically excluded from operating current assets. Any debt that incurs interest is also normally excluded from operating current liabilities.
As the name suggests, operating working capital strictly measures assets used for a company’s operations (e.g., inventory, equipment, and salaries and wages). Cash becomes a part of operating working capital once it is used to buy materials and supplies.
An Operating Working Capital Example
Here’s an example of a calculation for operating working capital using the formula:
Operating Working Capital = Current Operating Assets – Current Operating Liabilities
In a typical balance sheet or financial statement, you’d find these assets and liabilities:
| Assets | |
|---|---|
| Cash | $12,000 |
| Marketable Securities | $33,000 |
| Accounts Receivable | $17,000 |
| Inventory | $44,000 |
| Prepaid Rent | $9,000 |
| Prepaid Insurance | $3,500 |
| Liabilities | |
|---|---|
| Accounts Payable | $22,000 |
| Supplies Expense/Payable | $17,500 |
| Utilities Expense/Payable | $8,000 |
| Salaries and Wages | $25,000 |
Include short-term assets and short-term liabilities (except for cash, financial investments, and interest-bearing liabilities) to calculate OWC. Since we’re calculating the operating working capital, we don’t have to include long-term liabilities and long-term assets like real estate.
It will look like this:
(Account receivable + inventory + prepaid rent + prepaid insurance) – (Supplies expense + utilities expense + salaries and wages)
= ($17,000 + $44,000 + $9,000 + $3,500) - ($17,500 + $8,000 + $25,000)
= $73,500 - $50,500
= $23,000
Operating Working Capital vs. Net Working Capital: Key Differences
As mentioned above, operating working capital is calculated as operating current assets minus operating current liabilities. On the other hand, net working capital (NWC), or just working capital, is the difference between the total current assets and total liabilities of a business.
Here are the main differences between operating working capital and net working capital:
Operating working capital measures how much equity a business has in the form of current assets. In contrast, working capital measures a company’s financial health and profitability.
Operating working capital shows a company’s operational efficiency, while working capital shows how efficient a company is in using its capital to invest in money-making activities.
Operating working capital focuses on day-to-day operations, while net working capital gives the overall view of the company’s assets and liabilities.
Operating working capital indicates whether a company can cover its short-term obligations. In contrast, net working capital indicates a company’s creditworthiness in the long run.
How Do Working Capital Loans Work?
A working capital loan is a type of financing that provides funding to businesses to cover operating expenses. Business owners can use working capital loans to pay salaries and wages, purchase inventory, buy materials and supplies, and pay for utilities and rent.
This form of funding isn’t for long-term investments, such as buying real estate, but it’s really helpful in keeping businesses afloat during downturns or emergencies.
Some reasons to take out a working capital loan include:
- Working capital loans can help with seasonal dips where you need to buy more inventory and hire more people to get ready for peak season. It could also be the opposite: Your business has slowed down and you have less money coming in.
- It takes the stress out of waiting for your customers to pay while your bills are also due.
- Working capital loans can provide funding to help you improve business operations, such as maintaining or repairing broken equipment and hiring more workers.
- Working capital loans can help you take advantage of money-making or money-saving opportunities, such as having the cash to take advantage of supplier discounts by buying in bulk.
When funds are tight and cash flow is low, working capital loans can provide quick and easy funding for businesses to cover operational expenses. This gives business owners a chance to catch up until sales pick up or customers pay their invoices.
Working capital loans are also easier to qualify for, and you can apply through traditional banks and online lenders. However, online lenders may have fewer documentation and qualification requirements.
Working capital loans also tend to have more flexible terms than traditional small business loans. Since they’re mostly unsecured loans, you don’t have to put down collateral to guarantee them.
Types of Working Capital Loans
You can apply for several different kinds of loans, including:
Short-term loans: As the most common form of working capital financing, a short-term loan funds borrowers with a fixed loan amount. Then, the loan plus interest is paid back in regular monthly payments for a specified term length (i.e., the loan term).
Business line of credit: A business line of credit gives you access to an account with a set credit limit that you can use on an as-needed basis. It works the same as a credit card or home equity loan. You only get charged interest and pay back the amount you withdraw.
Invoice factoring: Invoice factoring is a financing option that allows you to borrow money by using your accounts receivable as collateral. Some invoice factoring companies will advance up to 99% of your invoice amount upfront. The lender gets their money back when they collect from your customers and you pay them a factoring fee for the service.
Merchant cash advance (MCA): Like invoice factoring, a merchant cash advance gives you money upfront in exchange for a percentage of your future credit card sales. The lender looks at your company’s creditworthiness, future sales, and past credit card receipts to negotiate your factor fee. Your payments are automatically deducted from your daily or weekly sales transactions.
Discover the Best Working Capital Loan Options From Clarify Capital
Your company needs working capital to fund its day-to-day operations and meet its short-term obligations. You have to watch your cash flow and maintain a positive working capital to build a profitable business.
Working capital loans give you access to loans with flexible payment terms. Most loans are unsecured (so you don’t have to put down any collateral), and the application process is quick and easy.
When you work with Clarify Capital, you’ll be partnered with a dedicated advisor who will guide you throughout the process. They’ll help you choose the best financing option based on your business needs.
And you get the best rate since we have a marketplace with more than 75 lenders. Fill out our online application for working capital loans today!