Negative working capital means the excess of current liabilities over current assets in an enterprise. Let’s understand what working capital is to get more clarity about negative working capital. Meaning of Working Capital Working Capital refers to the difference between current assets and current lRead more
Negative working capital means the excess of current liabilities over current assets in an enterprise.
Let’s understand what working capital is to get more clarity about negative working capital.
Meaning of Working Capital
Working Capital refers to the difference between current assets and current liabilities of a business.
Working Capital = Current Assets – Current Liabilities
It is the capital that an enterprise employs to run its daily operations. It indicates the short term liquidity or the capacity to pay off the current liabilities and pay for the daily operations.
Items under Current Assets and Current Liabilities
It is important to know about the items under current assets and current liabilities to understand the significance of working capital.
Current assets include cash and bank balance, accounts receivables, inventories, short term investments, prepaid expenses etc.
Current liabilities include accounts payable, short term loans, bank overdraft, interest on short term investment, outstanding salaries and wages etc.
Types of working capital
Since the working capital is just the difference between current assets and liabilities, the working capital can be one of the following:
- Positive (Current assets > Current liabilities)
- Zero (Current assets = Current liabilities)
- Negative (Current assets < Current liabilities)
Hence, negative working capital exists when current liabilities are more than current assets.
Implications of having negative working capital
Having negative working capital is not an ideal situation for an enterprise. Having negative working capital indicates that the enterprise is not in a position to pay off its current liabilities and there may be a cash crunch in the business.
An enterprise may have to finance its working capital requirements through long term finance sources if its working capital remains negative for quite a long time.
The ideal situation is to have current assets two times the current liabilities to maintain a good short term liquidity of the business i.e.
Current Assets = 2(Current Liabilities)
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Definition Current assets are defined as cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business. Or in other words, we can say that the expected realization period is less than the operating cRead more
Definition
Current assets are defined as cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business.
Or in other words, we can say that the expected realization period is less than the operating cycle period although it is more than the period of 12 months from the date of the balance sheet.
For example, goods are purchased with the purpose to resell and earn a profit, debtors exist to convert them into cash i.e., receive the amount from them, bills receivable exist again for receiving cash against it, etc.
List of current assets
The list of current assets is as follows:-
Now here are a few definitions for the above list of current assets which are as follows:-
Cash in hand
Cash comprises cash on hand and demand deposits with banks.
Cash equivalents
Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.
Bills receivables
It means a bill of exchange accepted by the debtor, the amount of which will be received on the specific date.
Sundry debtors
A debtor is a person or entity who owes an amount to an enterprise against credit sales of goods and/or services rendered.
Prepaid expenses
Expense that has been paid in advance and benefit of which will be available in the following years or year.
Accrued income
Income that has been earned in the accounting period but in respect of which no enforceable claim has become due in that period by the enterprise.
Closing stock
Stock or inventory at the end of the accounting period which is shown in the balance sheet and which is valued on the basis of the “ cost or net realizable value, whichever is lower “ principle is called closing stock.
Short term investment
Investments that are also known as marketable securities and are held for a temporary period of time i.e, for less than 12 months, and can be easily converted into cash are called short-term investments.
Criteria for classification
Now let us see the classification of assets in the case of companies as per Schedule III of the Companies act 2013.
An asset is a current asset if it satisfies any one of the following criteria which are as follows:-
Here is an extract of the balance sheet showing current assets
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