2) Importance of Working Capital for Business Growth
As an entrepreneur, individuals must make it a point to become familiar with the relatively new concept – zero working capital – for more clarity over the situation.
Usually, when an enterprise has the same amount of current assets and current liabilities, it has zero working capital. Such a situation arises when a company’s current liabilities fully fund its current assets, as highlighted in the table below:
Total Current Assets = Total Current Liabilities
or,
Total Current Assets – Total Current Liabilities = 0
Take a look at this example below to understand the concept of zero working capital.
Suppose a company, ABC Ltd., has the following balance sheet for the year ending on 31 March 2021.
Balance Sheet as on 31/03/2021 |
|
Assets Current Assets Cash Account Receivables Inventory Prepaid Rent |
50,000 1,80,000 1,75,000 1,55,000 ---------- 5,60,000 |
Long Term Assets Land and Building Plant and Machinery Furniture and Fixtures
Total Assets |
2,50,000 1,00,000 1,50,000 ----------- 10,60,000 |
Liabilities Current Liabilities Sundry Creditors Outstanding Expenses Bills Payable |
1,95,000 2,65,000 1,00,000 5,60,000 |
Long Term Liabilities Bank Loan
Total Liabilities |
5,00,000 ----------- 10,60,000 |
Using the data given above, one can calculate working capital in the following manner:
Therefore, as ABC Ltd. does not have an excess of current assets over its current liabilities, it has zero working capital.
If an enterprise can maintain zero working capital without incurring excessive liquidity risk, it can benefit the firm’s operations in the following ways:
Implementation Of Zero Working Capital
Although the concept may seem enticing, it is often challenging to achieve the same due to these reasons:
So, optimum working capital plays a key role as it allows a company to undertake day to day operations and critical investment decisions. A shortage of working capital can, therefore, be detrimental to a business. Also, when faced with such a cash crunch, businesses can leverage their tied up accounts receivable from KredX.
KredX is a leading cash flow solution provider that helps to address operating capital requirements. It helps businesses gain quick access to funds in 24-72 hours* by way of an easy digital process. Moreover, one need not pledge any collateral to avail funds, thus unlocking liquidity to maintain a healthy cash flow balance.
A company operating with a very high working
capital may indicate that it does not invest its
excess cash optimally. It can also denote that
this firm is neglecting its growth opportunities
and is solely focused on maximising liquidity.
In addition, an extremely high working capital may
imply that a business is overly invested in
inventory or that its collection of debts is
ineffective, thus highlighting operational
inefficiency and/or waning sales.
Companies employ this strategy to avoid excessive investments in current assets and pay off current liabilities by using their existing current assets only.
A company can reduce its working capital without jeopardising its ability to meet short-term obligations by adopting an on-demand production as well as distribution system or a just-in-time approach.