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 it more narrowly defines what constitutes those assets and liabilities. In terms of OWC assets are limited to inventory and accounts receivable, while liabilities are limited to accounts payable. By narrowing the scope to these basic elements, it prevents 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 portion of the equation includes cash and securities, while the liabilities may include any debt a company has accrued. Yet these numbers are more a reflection of a company’s financing structure rather than a true measure of its operational efficiency or day-to-day business strength. As a result, financial experts may rely on the concept of operating working capital as being more indicative of how well a company is doing business or how it stacks up against another in terms of investment opportunities.
To achieve this more accurate financial picture when calculating OWC, the assets and liabilities have to be separated from the excess numbers that are included in the working capital equation. When figuring out a company’s operating assets, all cash amounts must be subtracted from the total assets a company has, leaving just accounts receivable and inventory on that side of the ledger. In a similar fashion, 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, then it is relatively simple to determine the operating working capital of the business at hand. For example, company A has $10,000 US Dollars (USD) in operating assets and $8,000 USD in operating liabilities. Subtracting the $8,000 USD from the $10,000 USD leaves a total of $2,000 USD in OWC. That means that the company would have an excess amount of $2,000 USD even if it had to pay all of its bills immediately.
The concept of operating working capital is a beneficial measuring stick for newer businesses, which often accrue 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 that a company has, thus decreasing the amount that is subtracted from the operating assets.