What is zero working capital?

Working capital is defined as the difference between current assets and current liabilities of a business. Current assets include cash, debtors and stock whereas current liabilities include creditors and short term loans etc.

FORMULA

Current Assets – Current Liabilities = Working Capital

Zero working capital is when a company has the exact same amount of current assets and current liabilities. When both are equal, the difference becomes zero and hence the name, Zero working capital. Working Capital may be positive or negative. When current assets exceed current liabilities, it shows positive working capital and when current liabilities exceed current assets, it shows negative working capital.

Zero working capital can be operated by adopting demand-based production. In this method, the business only produces units as and when they are ordered by the customers. Through this method, all stocks of finished goods will be eliminated. Also, raw material is only ordered based on the amount of demand.

This reduces the investment in working capital and thus the investment in long term assets can increase. The company can also use the funds for other purposes like growth or new opportunities.

EXAMPLE

Suppose a company has Inventory worth Rs 3,000, Debtors worth Rs 4,000 and cash worth Rs 2,000. The creditors of the company are Rs 6,000 and short term borrowings are Rs 3,000.

Now, total assets = Rs 9,000 ( 3,000 + 4,000 + 2,000)
And total liabilities = Rs 9,000 ( 6,000 + 3,000)
Therefore, working capital = 9,000 – 9,000 = 0