Positive working capital is the excess of current assets over current liabilities. In other words, when the net working capital is a positive figure, it is said that the firm has a positive working capital. It is the situation when the short-term receivable of a company is more than its short-term payables. This is a desirable situation for the company; it ensures no bankruptcy circumstances.
We generally understand working capital as positive working capital only in the common business parlance. When does somebody ask how much is your working capital? Instantly, in the accountant’s mind, the equation of current assets less current liabilities would be calculated, and he would give you the answer.
Benefits/Advantages of Positive Working Capital (NWC)
Fight against Bankruptcy
We should have more dollars in our pocket than the list of expenses we have planned. On similar lines, from a liquidity and bankruptcy point of view, it is always desirable to have positive working capital. It ensures more incoming dollars than the planning of outgoing dollars. Suppose the situation is reversed, which is called negative working capital. In that case, the company may face liquidity issues and eventually lead to bankruptcy if it cannot satisfy its short-term debt/ payables.
Grab New Opportunities
A company with a positive WC is better positioned to take advantage of new business opportunities since the company has available supplier support and additional funds, which are a prerequisite to encash the new opportunity.
Funds Availability from Banks
Under normal circumstances, banks fund only the working capital gap and not the whole current assets. Working capital gap means net working capital. If the gap between current assets and liabilities is positive, the bank is keen to fund; otherwise not. As per banks, the company does not require funds.
Suppose the trade credit finances the current assets, i.e., current liabilities, by forgoing the discount allowed. The cost of trade credit is normally higher than bank finance. It is desirable to take bank finance and avail the trade discount given by the supplier.
There are many other advantages, and the above are the most important ones.
Disadvantages of Positive Working Capital (NWC)
Dependency on Banks
Companies having positive WC require funds from banks or financial institutions to run their business’s operating cycle. On the contrary, to avoid bank dependency company is dependent upon the suppliers for their business cycle. It is not necessary that the bank will definitely finance the working capital gap. They may have their reservations on the same.
If the Cost of Trade Credit is less than the bank’s finance, it is obvious that the company will save on the cost of funds, i.e., their interest cost, and increase its profitability.
In essence, the analysis of the case of working capital should from business to business. Most may have benefits in the positive working capital, but negative working capital may be beneficial for some. One should avoid nothing without even giving a thought to it.
Continue reading about other Types of Working Capital.