How is net working capital calculated and what does it indicate?

• A. Net working capital equals total assets minus total liabilities; indicates overall solvency.
• B. Net working capital equals cash balance minus debt; indicates liquidity.
• C. Net working capital equals current liabilities minus current assets; indicates working capital risk.
• D. Net working capital equals current assets minus current liabilities; indicates short-term liquidity and operational cushion.

Answer: (D)

Net working capital shows how much cushion a company has to fund its day-to-day operations in the near term. It is calculated by subtracting current liabilities from current assets. A positive result means there are enough short-term assets (like cash, accounts receivable, and inventory that can be turned into cash) to cover short-term obligations (like supplier payments and upcoming debts), providing flexibility in daily operations. A larger positive figure generally signals stronger short-term liquidity and a buffer for unexpected expenses, while a negative figure suggests potential liquidity stress and a need for financing or tighter working capital management.

The other ideas mix up what net working capital represents. Using total assets minus total liabilities measures overall solvency and equity, not the near-term liquidity picture. Using cash minus debt focuses on cash holdings versus borrowings rather than all current assets and current liabilities. Reversing the order to liabilities minus assets would imply the opposite sign and a different interpretation, not the standard measure of working capital.