Business Degree Certification Practice Test

What does "net working capital" refer to?

1. Assets divided by liabilities

2. Current assets less short-term liabilities

3. Inventories, receivables, and current notes and investments

4. Net assets left over after subtracting cost of goods sold

The correct answer is: Current assets less short-term liabilities

Net working capital is a key financial metric that represents the difference between a company's current assets and its current liabilities. It provides insight into the company's short-term liquidity position and operational efficiency. By subtracting short-term liabilities from current assets, net working capital indicates how much capital is readily available to fund day-to-day operations, pay off upcoming obligations, and invest in opportunities without risking insolvency. This metric is crucial for assessing the ability of a company to cover its short-term debts with its short-term assets. A positive net working capital suggests that a company has sufficient assets to meet its short-term liabilities, which is a sign of financial health. Conversely, a negative net working capital can indicate potential liquidity issues, suggesting the company might struggle to fulfill its short-term obligations. The other options pertain to different financial concepts. For instance, assets divided by liabilities relates to the debt-to-equity ratio, which measures financial leverage rather than liquidity. Inventories, receivables, and current notes and investments describe components of current assets but do not sufficiently define net working capital as it does not involve the subtraction of current liabilities. Net assets left over after subtracting the cost of goods sold refers to a different accounting measure that does not capture the short-term liquidity position represented