In the times of credit squeeze and softening economies, almost every company is looking for —
ways to reduce its fixed/current costs. However, they still need to support their strategic —
business initiatives and ensure sustainable growth. Thus, a cross-functional engagement
and shifting or elimination of tasks to create a leaner workflow and greater efficiency for the
whole organization is required. In such difficult times, continuing with the traditional framework
of capital would not help companies to focus on long-term financial decisions, such as
analyzing investments of capital structure, dividends, company valuation, etc. Even short-term
investments, which have a maturity span of less than one-year, also represent a major part of the
firm's balance sheet. This is mostly in the form of cash that is used for day-to-day activities, i.e., to
pay wages, purchase raw materials, etc. The cash available for this purpose is known as
working capital. In terms of financial accounting analysis, working capital is termed as the
difference between current assets and current liabilities. The amount showcases the capital that is
not invested in any long-term assets, like plant, machinery and buildings, but rather used as
cash and inventories on daily basis for the firm's operations. Apart from this, accounts receivable
and payable are also considered as working capital elements of the firms. Thus, in a way,
while working capital's effective provision can ensure the success of any business, its
inefficient management can lead to, not only loss, but also the ultimate failure of the concern.
This capital can be distinguished into two types—one known as Positive Working Capital
and the other as Negative/Zero Working Capital. In the former, the current assets exceed the
current liabilities whereas in the latter case, the current liabilities of the firm exceed its current assets.
It is a myth that negative or zero working capital is always bad. In fact, many modern day
companies are of the opinion that rather than trying to adopt various forms of financing, many of them
try to avoid the need for financing. This is how the concept of zero working capital emerged
whereby, the sum of the company's investment in accounts receivable and payable, along with
inventory, becomes nil. Even the management supports this concept of zero working capital, as
working capital seldom earns any returns. Further, such capital can be used for various other
purposes. However, firms should guard against trying to achieve zero working capital at the cost of its
sales volume in cases where business is funded by customers, which means that the company is in
a good condition and debtors are prepared to wait. The companies that are able to generate
quick cash achieve zero working capital quite easily. For this, much depends on the operating cycle
of the company too, where they can generate or collect some funds prior to the receipt of
certain payments. Hence, a zero working capital is also a sign of managerial efficiency in a business
with low inventory and accounts receivable (which means that they strictly operate on cash
basis). |
