Tracking Cash & Net Working Capital

Tracking Cash & Net Working Capital
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  • 0:04 Business Assets
  • 0:47 Net Working Capital
  • 1:59 Tracking Cash
  • 3:46 Lesson Summary
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Lesson Transcript
Instructor: Natalie Boyd

Natalie is a teacher and holds an MA in English Education and is in progress on her PhD in psychology.

How can businesses track their cash flow and understand how their assets and liabilities align? In this lesson, we'll examine how to track cash flow, including the calculation of net working capital and the accrual method of accounting.

Business Assets

Johanna has a business that makes fun and stylish jewelry. She sells the jewelry to stores across the country, and the stores sell it to customers. Johanna's business has some assets, or things worth something to the business, such as cash, supplies to make new jewelry, and orders that haven't been paid yet. But the business also has some liabilities, or things that the business owes. For example, Johanna took out a business loan, and she has to pay rent on her workshop and office.

Johanna wants to know how she should keep track of what her business owns and what it owes. To help her out, let's look at two important elements in asset management: net working capital and tracking cash through the accrual method of accounting.

Net Working Capital

As we mentioned, Johanna's business has both assets and liabilities. How does she know if her business is financially healthy? One way to judge that is by calculating net working capital, which is the business assets minus the business liabilities. For example, if Johanna's business has $500,000 in assets and $100,000 in liabilities, then her net working capital would be $400,000.

Net working capital gives a quick snapshot of the financial health of a business. A high number is good, because it indicates that a business has enough working capital, or assets, to pay for any expenses that come up in the future. A high net working capital also indicates that a company could expand the business.

But net working capital can be misleading too. For example, Johanna's company has a large line of credit, which they can draw on if they get into financial trouble. This isn't reflected in net working capital. In addition, one chain of stores buys a huge amount of jewelry and pays for it every three months. So if her company's net working capital is calculated in the month before the chain of stores pays for their order, it will be lower than in the month when they receive the cash.

Tracking Cash

Because net working capital can be deceiving, Johanna wonders if there's a better way. She is especially curious about how to track cash flow in and out of her company. For example, though the chain of stores only pays Johanna every quarter, she has to ship out jewelry to their stores every month. That means she's buying supplies and paying workers to make the jewelry every month, even though the company isn't paid for that jewelry until the end of the quarter.

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