What Is Non-Cash Working Capital? (Plus How To Calculate)

Investors evaluate new companies for investment based on a variety of metrics that indicate an increase in the company's profits. One indicator that investors look at is a company's working capital (WC), which incorporates the idea of non-cash working capital (NCWC). Knowing how to calculate the NCWC can help you convince investors of a company's value and identify the strengths and weaknesses of companies well enough to make wise investments yourself. In this article, we define NCWC, explain its relationship with other financial metrics and show how to calculate it using two different formulae.

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What Is Non-Cash Working Capital?

Businesses employ non-cash working capital to fund their operations in addition to liquid cash. It incorporates a company's inventory of unfinished products, raw materials and accounts receivable. The NCWC, which can be either positive or negative, is the difference between current liabilities and non-cash current assets. If the net change in NCWC is positive, the working capital has increased in the current year. A reduction in working capital occurs if NCWC is negative. You can deduct a company's obligations, which include debts and accounts payable, from its capital to obtain an accurate view of its assets.

When discussing the purchase or sale of a company, NCWC is one of the most contentious topics. When a buyer buys a company, the purchase price includes all of the assets required for day-to-day operations, which includes NCWC. This aids the prospective buyer in comprehending the amount of operating capital necessary to maintain the company's operations. The due diligence process frequently estimates the historical NCWC of the target on a monthly basis for two to three years to establish how much working capital the company requires to sustain ongoing operations.

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Relationship Of NCWC With Other Financial Metrics

As NCWC is closely related to other crucial corporate financial metrics, it is essential to understand how it differs from them, impacts them or has a relation to them. These financial metrics are as follows:

Working capital

Working capital (WC) is the difference between current assets and current liabilities that a business can use for day-to-day operations. We can represent it with the following formula:

WC = Assets - Liabilities

NCWC is the total of receivables and inventory, determined by factoring in the value of all current assets of the company, excluding cash, and subtracting current liabilities. You can calculate NCWC in the following two ways:

NCWC = Non-cash current assets - Current liabilities

or

NCWC = Receivables + Inventory - Payables

The connection between WC and NCWC is such that if a company's NCWC falls, it is because it got payments from accounts receivable or sold inventory. As a result of this drop in NCWC, the company's cash WC rises.

Related: What Is Working Capital Management? (Importance And Ratios)

Turnover ratio

Turnover is the rate at which a business purchases and sells merchandise, or accumulates accounts receivable and collects payments. A high turnover rate is something that businesses frequently strive for because it indicates that they are making sales and gaining a profit. A low turnover rate may indicate that a corporation is losing money on its assets before turning them into cash. Investors can monitor a company's NCWC turnover, or how frequently non-cash assets are converted into cash assets, to assess its financial health and stability.

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Cash flow

The net amount of cash and cash equivalents coming into and going out of a business is known as cash flow. It gives you a comprehensive view of the company's inflows and outflows by projecting all revenue and outlays over a predetermined time frame. A company's ability to pay forthcoming obligations may depend on how much NCWC it has. It is desirable to have a low NCWC when there is a high net working capital. This is because the amount of cash the corporation possesses increases as the percentage of non-cash items in the total decreases.

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Free cash flow

The amount of money a corporation has available to pay off debt, dividends and interest to investors is called free cash flow (FCF). FCF reconciles net income by determining how much cash is still available after a business makes adjustments for non-cash costs, working capital and capital expenditures (CapEx). FCF removes all non-cash elements from the profit-and-loss statement to give investors a perspective of the business performance before they pay any money to creditors or stakeholders.

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Discounted cash flow (DCF)

Discounted cash flow (DCF) refers to a method of valuation that calculates an investment's value based on its anticipated future cash flows. It bases the value of a firm on the current value of its future cash flows. The DCF equation's future cash flows are its free cash flow figures. NCWC can give investors more details about a company's projected cash flow based on its present non-cash assets. When evaluating a corporation using DCF, NCWC takes precedence over typical net working capital.

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How To Calculate NCWC

There are mainly two ways of calculating NCWC. It is necessary to use an updated balance sheet for both of these calculations. They are:

Using current assets

Follow these steps to calculate the NCWC using this method:

1. Calculate current assets

Assets that are easy to convert to cash in less than a year are called current assets. Through the course of a business's regular activities, it is reasonable to expect that the company is going to sell, use up or consume these assets. To calculate NCWC using current assets, first, calculate the current assets of the company using this formula:

Current assets = Cash + Cash equivalents + Inventory + Accounts receivable + Marketable securities + Prepaid expenses + Other liquid assets

2. Calculate non-cash current assets

Non-cash current assets are difficult to turn into cash and have benefits that may take longer than a year to materialise. You require the company's non-cash current assets to calculate its non-cash WC. To do so, subtract the company's liquid cash and marketable securities from its current assets, using the formula below:

Non-cash current assets = Current assets - Liquid cash - Marketable securities

3. Calculate current liabilities

A company's current liabilities are its debts or commitments that it requires to repay to creditors within a year. You can calculate a company's current liabilities using this formula:

Current liabilities formula = Notes payable + Accounts payable + Accrued expenses + Unearned revenue + Current portion of long-term debt + Other short-term debt

4. Compile the NCWC

Now that you have a figure for both non-cash current assets and current liabilities, subtract the latter from the former to get the NCWC for the company for that fiscal year. Here is the formula:

NCWC = Non-cash current assets - Current liabilities

Related: How To Read A Balance Sheet (Components And Template)

Using accounts receivable and payable

Follow these steps to calculate the NCWC using this method:

1. Calculate accounts receivable

The balance of money a business is yet to receive for goods or services clients have purchased or used but not yet paid for is known as accounts receivable (AR). The company's balance sheet or general ledger lists the number of accounts receivable under the heading current assets. The fact that accounts receivable add value to the organisation in the form of potential future cash payments qualifies them as assets.

2. Calculate inventory

The company's balance sheet also includes the inventory value. After calculating accounts receivable, calculate the inventory. You can use the following calculation to determine the worth of a company's inventory manually:

Inventory value = Number of items in inventory x The unit price of the item

3. Calculate accounts payable

Accounts payable (AP) is the term used to describe the unpaid balances owed to suppliers or vendors for products or services the company has received. The accounts payable balance is present on the company's balance sheet as the total of all unpaid sums to vendors. You can also figure it out manually by totalling up all of the approved invoices that are due payment.

4. Compile the NCWC

The last step of the process is to calculate the NCWC. After you have the accounts receivable, inventory and accounts payable figures, you can calculate NCWC using this formula:

NCWC = Receivables + Inventory - Payables