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The term negative working capital is derived from the concept of working capital. To begin with, I would like to briefly explain the meaning of working capital.
In simple terms, Working Capital refers to the total amount of current assets excluding the total amount of current liabilities in a business. It can have a positive or a negative value, wherein the two are an indicator of the well-being of a business. The formula to calculate working capital is as follows:
| WORKING CAPITAL = TOTAL CURRENT ASSETS – TOTAL CURRENT LIABILITIES |
Negative Working Capital
In simple words, Negative working capital refers to the excess of net current liabilities over the net current assets. As the word itself suggests, a ‘negative’ working portrays a downfall in the financial position of a business and its inefficient functioning.
A company is said to be facing financial difficulty and is not in a position to pay off its debts when the value of working capital is negative.
| NEGATIVE WORKING CAPITAL = TOTAL CURRENT LIABILITIES > TOTAL CURRENT ASSETS |
Example
Calculate the working capital of XYZ Ltd.
(Extract of Balance Sheet)
| PARTICULARS | AMOUNT |
| CURRENT ASSETS | |
| Cash and Cash Equivalents | 36,000 |
| Accounts Receivables | 20,000 |
| Stock Inventory | 15,000 |
| Marketable Securities | 35,000 |
| Prepaid Rent | 7,000 |
| TOTAL CURRENT ASSETS | 1,13,000 |
| CURRENT LIABILITIES | |
| Accounts Payable | 15,000 |
| Accrued Expense | 4,000 |
| Deferred Revenue | 40,000 |
| Taxes Payable | 50,000 |
| Short–Term Debt | 10,000 |
| Interest Payable | 7,000 |
| TOTAL CURRENT LIABILITIES | 1,26,000 |
Note: As we can see the total current liabilities of XYZ Ltd. are exceeding the total current assets therefore, the working capital is negative.
Working capital = Total current assets – Total current liabilities
= 1,13,000 – 1,26,000
= (13,000)
