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Net working capital is one of the classic measures of a company's liquidity. Net working capital is a pure balance sheet measure, as such it can be calculated at any time without worrying about annualizing the calculation as is necessary when calculating ratios that use both the income statement and balance sheet together - such as accounts receivable turnover.
The formula for net working capital is:
Net working capital = current assets - current liabilities
Many lending institutions and financing facilities like to use working capital as one of the covenants that need to be maintained.
Example:
Google Inc
Fiscal periods ended 12/31/05 12/31/06 9/30/07
<--------In Millions of Dollars------->
Current assets $9,001 $13,039 $15,734
Current liabilities 745 1,304 1,783
Net working capital $8,256 $11,735 $13,951
As can be seen, Google continued to add to their net working capital over the period analyzed.
The components of net working capital are also used to calculate the current ratio.
