Negative Working Capital:
Company needs working capital to
meet the day to day expenses. As we discuss in previous post that the difference
between current assets and current liabilities is known as working capital.
The negative working capital arises
when current liabilities more than current assets. The negative working capital
shows that the company is not able to pay its short term debt within a year.
Negative working capital is bad or good for company. If the current ratio is less
than 1 shows that the current liabilities more than the current assets and that
states is known as net working capital.
Advantages of Negative Working Capital:
§ Saves bank interest: If company purchase
goods on credit from his suppliers who knows the company situation very well
then company doesn’t need to borrow money from bank for purchasing goods and pay interest on
borrowed funds. Purchase goods on credit from suppliers, company don’t need to
pay interest on it and there is no fixed time to pay it back to suppliers if
there is no contract between them.
§ Earn Interest: Company purchase goods
on credit from suppliers and sell the goods for cash. The cash collected from
sales is invested in securities to earn interest on it.
Disadvantages of Negative Working Capital:
§ Bad financial position: Negative working
capital shows company is not able to pay its liabilities within a year. And company’s
financial position is not good to meet its day to day requirements.
§ Lack of Investors confidence: Investors
invest their funds in those companies who have sound financial position to earn
return on its investment. If company is not able to pay its debt and purchase
goods on credit and recovery of cash from customers is low. At that point there
is no profit in a company and chances of recovery of investors investment
amount is low then how they earn return on it.
§ Low Market position: The market position of a company is low and it loses its customers.
§ Creditors claim for funds: Creditors
can sue on company’s assets. So, by selling the assets they can recover their
funds.
Net working capital
= Current liabilities – Current Assets
Example: Find out the net working
capital with the help of given information:
Bank overdraft
= Rs. 2, 000
Bill
receivable = Rs. 15, 000
Cash = Rs. 8,
000
Outstanding
salary = Rs. 14, 000
Short term
investment = Rs. 10, 000
Accrued income
(unearned income) = Rs. 12, 000
Bills payable
= Rs. 20,000
Inventory =
Rs. 18, 000
Creditors =
Rs. 40, 000
Solution:
Total current
assets =bill receivables + Cash + Short term investment + Accrued income +
inventory
= 15, 000 + 8,
000 + 10, 000 + 12, 000 + 18,000
=Rs. 63, 000
Total current
liabilities = Bank overdraft + Outstanding salary + Bills payable + Creditors
= 2, 000 + 14,
000 + 20, 000 + 40, 000
= Rs.76, 000
Net Working
Capital = Current Liabilities – Current Assets
= Rs. (76, 000
– 63, 000)
= Rs. 13, 000
We can also
calculate net working capital with the help of current ratio:
Current ratio
= Current assets / Current liabilities
= 63, 000 /
76, 000
= 0.82:1
The current
ratio is less than 1 which shows negative working capital because the current
liabilities is more than current assets.
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