Negative working capital: when it's good and when it's bad

A firm's working capital is calculated using the current assets and current liabilities declared by the firm in its officially published financial statements. Current assets are the firm's assets that can be monetized within one year. These include bank balances, investments, and accounts receivable. Similarly, current liabilities are the amounts the firm must pay its debtors within the next year. The difference between current assets and current liabilities is the firm's working capital. Can the change in net working capital be negative? In some cases or industries, a firm's current liabilities will exceed its current assets and the firm will have negative working capital. This could be intentional due to business model or unforeseen business related issues.

What happens if the firm has negative working capital?

Typically, when working capital is negative, the firm's current liabilities exceed its current assets, which is an example of poor cash flow management. However, there is one case where negative working capital is an advantage for a business.

Companies looking for acquisition targets should be aware that there are several business models in which negative working capital is considered a positive attribute.

Advantages of Negative Working Capital

Negative working capital is a positive attribute of a firm if it generates cash quickly because the firm can sell products to customers before paying suppliers. One of the most famous brands used in the study of negative working capital is Dell Computer, whose business model has allowed it to have negative working capital for many years. The company receives cash upfront from customers at the time of order. However, it later pays suppliers of computer hardware and other services. In general, very few well-known firms have a significant advantage over their competitors that allows them to have negative working capital.

However, in the case of Dell Computer, when evaluating acquisitions of companies, it indicates that negative working capital can be viewed as a positive business characteristic in some industries

Disadvantages of Negative Working Capital

Companies with negative net working capital usually have cash flow problems. Most business buyers consider negative working capital as a major disadvantage when evaluating various firms for acquisitions. This is because after the purchase agreement is finalized, the business buyer must seek additional working capital to run the business. Typically, companies looking for acquisition targets will also check the company's working capital ratio. Most buyers prefer businesses with a working capital ratio of at least 1 to 1.5. This ensures that the firm has assets of sufficient value to cover its current liabilities. The company buying the business, in this case, can be assured that the business itself will generate enough cash to pay off its suppliers and employees in the short term

What do negative working capital days mean?

Negative working capital days are the number of days that liabilities exceed the company's assets. A low negative working capital days value usually means that the firm is using its working capital quickly and converting it to sales. Firms that use negative working capital as their business model typically have low negative working capital days.

Negative Working Capital and Workload

Another factor that determines the desired net working capital ratio is the carrier of the business model. The period it takes for a firm to receive payments from customers, convert receivables into cash in the bank account, and make payments by suppliers from employees can be much higher than the standard one, because the long carry period affects the firm's cash flow for experienced and competent buyers in this case working capital ratio.

To summarize

Negative working capital is generally a bad thing because the firm's liabilities exceed its current assets, and this can be a disadvantage if someone wants to evaluate the firm for an acquisition However, negative working capital is also good if the firm generates cash quickly because it can sell products to customers before paying invoices to suppliers This is also good if the firm generates cash quickly because it can sell products to customers before paying suppliers' invoices.