Negative Working Capital Meaning
Negative working capital is when the current liabilities of the company are more than its current assets, which suggests that the company has to pay off a bit more than the short term assets it has for a particular cycle.
- Most of the time, this is not considered as a good sign, but there are cases where negative working capital is good for the organization.
- Sometimes it means that the company can generate the cash so quickly that it gets time in between to pay off its suppliers and creditors. So basically, the company is using the suppliers’ money to run its day-to-day operations.
- Though this means a good idea, having the negative working capital to its advantage is not everyone’s cup of tea. The companies which deal with cash only businesses or where the receivables time is too short often have negative working capital.
How to Check whether Negative Working Capital is Good or Bad?
A quick but may not be the best way to see if negative working capital is good for the company or not is to check the data of receivables and payables. If the payables period is longer than the receivable days, then the company gets more time to pay back its due, and it gets its cash quite early.
So that’s a good sign. But if the receivables period is too high and payables are too low, and the company has a negative working capital, then it can pose a serious problem for the organization to runs its day-to-day activities.
- A firm’s working capital structure might change as the strategies of the companies change. McDonald’s had a negative working capital in the years between 1999 and 2000, but if you see now, it has a positive working capital.
- The auto retailer company AutoZone had $155 million in its negative working capital. It primarily moved to an efficient inventory turnoverInventory TurnoverInventory Turnover Ratio is a measure to determine the efficiency of a Company concerning its overall inventory management. To calculate the ratio, divide the cost of goods sold by the gross inventory. , where it stopped having a bulk of inventory and sold goods as early as possible and freeing its own capital needs.
- So you need to study the financial statements of a companyFinancial Statements Of A CompanyFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. for a few years, and then you can conclude whether it is good or bad for that particular company to have negative working capital.
- Though negative working may not always be good, too high positive working capital is also not ideal. Because if a company has too high positive working capital, it means it has a lot of current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc. and very few current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc.. So the company is not using its cash and cash equivalents to its optimum use and is just sitting on cash.
- So there is an opportunity lost for the company because it can use the cash and cash equivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. somewhere else to have decent returns on it. Industry-Standard working capital is ideal, and it changes according to the sector/industry of the company and its needs.
Negative Working Capital Examples
The industries which are primarily expected to have negative working capital and don’t pose a serious risk are
- Grocery Stores
Any industry which makes money through cash at the moment it sells a product/service will have money at its hand. So it can pay back its supplier through a credit period and create a chain. The companies which have a higher credit period for their receivables may not be able to justify the negative working capital that is good for them.
It has a great advantage because the company uses the money of suppliers and doesn’t have to depend on banks for funds. For example, if a company takes the product from a supplier and has a time of 60 days to pay to the supplier. It sells its products to its customers in 20days and gets the money in cash; then the company gets 40 days to pay back to its supplier. This money can be used by the company to get products from another supplier. In this way, it can create a chain where it uses the suppliers’ money to its advantage and doesn’t have to borrow money from a bank.
It can pose a serious issue if the company has the same structure for many years. Because ideally, not every year, a company will get to use supplier’s money. So this can hamper the day-to-day activities of the company and bring the operations to a halt.
Analyze the working capital of a company for the past few years and then find out whether the working capital structure is as per the industry standards. If the company is selling its products/services in cash and is paying its suppliers with a credit periodA Credit PeriodCredit period refers to the duration of time that a seller gives the buyer to pay off the amount of the product that he or she purchased from the seller. It consists of three components - credit analysis, credit/sales terms and collection policy., then the negative working capital will be good for such a company. A too high positive working capital is not good because there is an opportunity loss for the cash of the company because it is idle.
The working capital structure of a company can change depending on its strategies/goals for the future. So do analyze the rationale behind the change well and then decide the financial strength of the organization and whether it can run its day-to-day operations smoothly.
This has been a guide to What is Negative Working Capital and its Meaning. Here we discuss how to check whether negative working capital is good or bad along with examples, advantages, and disadvantages. You can learn more about excel modeling from the following articles –