Video:How Can Negative Working Capital Be Good?with Abby
Working capital is a sign of a successful business, especially if it is managed correctly. Here are a few tips on the benefits of negative working capitol.See Transcript
Transcript:How Can Negative Working Capital Be Good?
Hi, I’m Abby for About.com. For many companies, having and maintaining working capital is step one in running a successful business. What is working capital?
Working capital is what’s left after you deduct current liabilities from current assets. Assets include cash, inventory, and accounts receivable. Put another way, working capital is what you have left when you deduct what you owe others from the sum total of what you have and what you are owed.
Positive vs. Negative Working Capital
Positive working capital is good – it means you have enough cash on hand to do business. Negative working capital means that a company currently is unable to meet its short-term liabilities with its current assets. How, then, could negative working capital be a good thing?
For some businesses, customers pay with cash up front, so the company sells and delivers the product before the company ever pays its supplier for the goods.
How to Gauge Negative Working Capital
To get an idea of how it works, let’s use Wal-Mart and Paramount Pictures as an example. Imagine that Paramount sells Wal-Mart 5 DVD’s at $5 each and wants payment within ninety days. Now also imagine Wal-Mart had other costs of $3 in making the sales. Therefore, it has $22 in cash but still owes Paramount $25, thus having negative working capital.
Somewhat surprisingly that retailer might be so efficient it can sell those DVD’s for $5 each and still make money. How? They have one big benefit in their favor – the time value of money. Assume Wal-Mart sold those 5 DVD’s in 10 days.
That means that Wal-Mart can then invest or bank the $22 for 80 days, and earn money off the interest or earnings. When it comes time to actually repay Paramount, Wal-Mart’s $22 may now be $28 dollars and after paying back Paramount it made $3. Now multiply that by millions or billions and you can see how negative working capital might be a sign of a well run and efficient business.
If Wal-Mart can continue to do this with all of its suppliers, it doesn't really need to have enough cash on hand to pay all of its accounts payable. As long as the transactions are timed right, they can pay each bill as it comes due, maximizing their efficiency.
Negative Working Capital Signifies Efficient Management
The bottom line: A negative working capital is a sign of managerial efficiency in a business with low inventory and accounts receivable (which means they operate on an almost strictly cash basis). In any other situation, it is a sign a company may be facing bankruptcy or serious financial trouble.
You can tell if this is the case by comparing a company's accounts payable to the total inventory on the balance sheet.
We hope these resources provide you with the knowledge of how working negative capital can be beneficial to your business. For more information on working capital and business, please visit our Beginners’ Investment section on the web at About.com.Thanks for watching!