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What is Negative Working Capital?


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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