What is Operating Working Capital?
Operating Working Capital (OWC) measures the current assets and current liabilities used as part of a company’s core, day-to-day operations.
Notably, cash and cash equivalents are excluded from the calculation, as well as debt and any interest-bearing securities with debt-like features.
How to Calculate Operating Working Capital (Step-by-Step)
The traditional textbook definition of “working capital” refers to a company’s current assets minus its current liabilities.
The “current” categorization signifies an asset that can be converted into cash within twelve months (i.e. high liquidity), or a liability that is coming due within the next twelve months.
However, a more practical variation of working capital is the operating working capital (OWC) metric, which is adjusted to only include items with an integral role in the recurring, core operations of a company.
Specifically, OWC intentionally excludes “Cash and Cash Equivalents” and “Short-Term Debt”.
- Cash and Cash Equivalents Exclusion → The issue on-hand is that cash (and items such as short-term investments) are not necessarily an integral component of a company’s cash flow generation. In fact, the categorization of cash as a “Cash Flow from Investing” activity can be argued as more accurate than under “Cash Flow from Operations”, i.e. a company’s cash can be invested into short-debt government securities, marketable securities, certificate of deposit (CD), and more.
- Debt and Interest-Bearing Securities Exclusion → The borrowing of capital, i.e. debt and any debt-like instruments are more akin to a “Cash Flow from Financing” activity since these items represent a method of raising the necessary capital to fund ongoing operations.
Operating Working Capital Formula (OWC)
The formula for calculating a company’s operating working capital is equal to the operating current assets subtracted by the operating current liabilities.
The table below provides examples of the most common operating current assets and operating current liabilities.
|Operating Current Assets||Operating Current Assets|
OWC-to-Sales Ratio Analysis
The OWC of a company can be expressed as a percentage of sales to compare a company’s ratio to other companies within the same sector.
Calculating the OWC-to-sales ratio is relatively straightforward, as it compares a company’s OWC to sales.
Generally, companies should avoid the ratio from becoming too high, which is a subjective measure and entirely dependent on the industry.
- High OWC-to-Sales Ratio → More Cash Tied-Up in Operations, i.e. Less Liquidity
- Low OWC-to-Sales Ratio → Less Cash Tied-Up in Operations, i.e. More Liquidity
Operating Working Capital Calculator – Excel Model Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
OWC Calculation Example
Suppose a company had the following operating working capital line items in 2021.
Operating Current Assets:
- Accounts Receivable = $25 million
- Inventory = $40 million
- Prepaid Expenses = $5 million
Operating Current Liabilities:
- Accounts Payable = $15 million
- Accrued Expenses = $10 million
- Deferred Revenue = $5 million
By calculating the sum of each side, the following values represent the two inputs required in the operating working capital formula.
- Operating Current Assets = $25 million + $40 million + $5 million = $70 million
- Operating Current Liabilities = $15 million + $10 million + $5 million = $30 million
Upon netting those two values against each other, the operating working capital of our hypothetical company is $40 million.
- OWC = $70 million – $30 million = $40 million