Negative working capital is when a company’s short-term or current liabilities are greater than its assets. Although this seems counterintuitive, negative working capital can be beneficial, depending on the business and industry. Certain businesses that move inventory quickly can take advantage of a negative working capital strategy.
Working capital is the money used by a company to fuel its short-term or day-to-day liabilities. Typically, it’s calculated as current assets minus any liabilities. Negative working capital is when the result of this equation is negative, meaning that the liabilities are greater than the assets in the short-term, day-to-day operations. To laymen in the business world, this probably seems like a terrible scenario.
However, as with many things in this world, it’s not always that simple.
Negative working capital, when used properly, can be an asset to companies trying to reach the best possible “working capital efficiency.” In fact, many industries, particularly the retail and telecom sectors, have successfully employed a negative working capital strategy to realize maximum gains for their business and shareholders.
Different types of working capital
In its most basic form, working capital — also known as “net current assets” or “net working capital” — is an equation of assets minus liabilities.
The result of this equation is either positive working capital, negative working capital, or zero working capital.
Positive working capital
Positive working capital is when a company’s assets are worth more than its liabilities. This seems good on the surface because the company can pay all its bills in the short term with its current assets. However, this can be a drawback in many cases, particularly in retail.
For instance, one possible explanation for positive working capital is that the company has too much inventory that is not being sold or used. Although the assets (inventory) are greater than the liabilities (debts), assets being stuck in inventory means less efficient working capital. This phenomenon of unsold inventory is also referred to as “trapped liquidity.”
Positive Working Capital Example:
$100,000 (Assets) – $50,000 (Liabilities) = $50,000 (Working Capital)
Zero working capital
Some experts believe that zero working capital is the peak of working capital efficiency. If the accounts receivable equal the accounts payable, the working capital equates to zero. This typically means the company is not taking on excessive debt to help fund its working capital.
This might seem like the most efficient form of working capital, but it can have its own downsides. For instance, a company with zero working capital is more vulnerable to economic shocks. If inventory suddenly stops selling, short-term liabilities will become far more difficult to pay off.
Zero Working Capital Example:
$100,000 (Assets) – $100,000 (Liabilities) = $0 (Working Capital)
Negative working capital
Negative working capital is when a company’s liabilities are greater than its assets. There are multiple interpretations of how negative net working capital can affect a business.
If negative working capital arises in the short term, that can be a sign that the company has bought a large amount of inventory in response to an increase in sales.
However, if the company maintains negative working capital in the long term, it could be a sign of more fundamental financial issues.
Negative Working Capital Example:
$50,000 (Assets) – $100,000 (Liabilities) = –$50,000 (Working Capital)
Want to learn more about companies with efficient working capital and sky-high growth projections? Here are some investment advisors that can help:
Why companies change their capital strategies
A company might change its capital strategy based on the trajectory of its business. For example, imagine a company has an idea for a new product that would require a substantial investment. In this case, management might want to keep more capital free to invest in this product. Once the investment is fulfilled, the company may then shift to a strategy geared toward negative working capital to increase efficiency.
One real-life example of a business changing its capital strategy over time is McDonald’s. The company had negative working capital in 1999; these days, however, it maintains a positive working capital cycle.
When is negative working capital good?
Ideally, a company quickly generates negative working capital because it’s good at selling. It orders huge amounts of inventory, thus increasing its accounts payable, and then rapidly sells that inventory.
As the business generates cash, it orders even more inventory before paying the accounts payable, resulting in negative working capital.
Telecommunications firms are an example of an industry in which negative working capital is standard. This is because telecom companies need to pay a large proportion of their costs at the beginning of the year, which consistently leaves them with more liabilities than assets.
It might seem unusual for telecom companies to have negative working capital if they don’t manufacture products, but expenses such as license fees, spectrum costs, and tower installations require a huge amount of capital.
That being said, negative working capital does not mean such companies are bad investments. High growth rates mean these companies can ask for larger credit periods while they work to expand their user base, eventually allowing them to pay off liabilities. It’s worth noting that this working capital cycle is unique to telecom companies and thus is difficult to compare to other industries.
When is negative working capital bad?
Negative working capital also has its downsides. For one, it doesn’t allow much room for maneuvering should current liabilities greatly exceed current assets. If a company goes into too much debt, it risks bankruptcy.
Furthermore, a business with negative net working capital may be downgraded by independent debt analysts, making it more difficult to borrow money at lower interest rates. This can trigger a cycle in which higher interest rates increase current liabilities, pushing the company further toward unsustainability.
Negative working capital can also pose an obstacle to companies looking to invest in R&D or growth opportunities. After all, a company needs assets to fund its growth strategy.
Working capital and JIT supply chain logistics
In December 2020 and January 2021, the working capital marketplace CF20 surveyed more than 6,700 small and medium enterprises and asked them about their working capital requirements. The survey found a sharp increase in the costs of financing working capital post–Covid-19, compared to pre-pandemic years. This was due to interruptions in supply chains that were using an approach called JIT, or “just in time.”
What is a JIT strategy in business?
The JIT business strategy was pioneered in 1980s Japan. The strategy involves keeping inventory and trapped liquidity low and negative working capital high, with the goal of making capital more efficient by not wasting money on excess inventory. This allows companies to take money that would otherwise be tied up in inventory and invest it elsewhere in the business.
However, as the COVID-19 pandemic proved, a supply chain disruption can immensely strain this JIT strategy. For instance, imagine you were a company selling computerized toys. A chip shortage would mean you couldn’t manufacture and sell the final product, leading to a delay in your accounts receivable. If you maintain a consistent negative working capital balance sheet, you probably have other people in the supply chain extending credit to you, so your accounts payable payments would also be delayed. As you can see, a single disruption can impact the entire supply chain and cause problems for everyone involved.
What does it mean if working capital is negative?
If working capital is negative, it means a company’s short-term liabilities are greater than its assets.
Is having negative working capital good?
Any working capital can be good if a company uses it efficiently. Companies with efficient working capital, even if they maintain a negative balance in the short term, are considered good investments.
Can you give an example of negative working capital?
One example of standard negative working capital is telecom companies. They spend a significant amount of their money upfront for expenses such as tower installations and licensing fees. Thus, they consistently maintain negative working capital at the beginning of the year.
Is it better to have positive or negative working capital?
Both negative and positive working capital can be good for a business. What matters is if the company uses its working capital efficiently.
- Working capital is a company’s ability to fund short-term liabilities and day-to-day operations with its assets.
- Negative working capital is when a company’s liabilities are greater than its assets in the short term.
- Working capital can be positive, negative, or zero.
- Negative working capital can be good in some cases — for example, if a company does not have trapped liquidity due to excess inventory.
- Negative working capital is a strategy commonly employed by some industries, such as retail and telecommunications.
- JIT, or “just in time,” is a supply chain logistics strategy that involves keeping as little excess inventory as possible. In many cases, companies that use this strategy will maintain a negative working capital balance.
- The global COVID-19 pandemic has led many people to rethink this strategy. Today, this debate is a major focus of the business and political communities.
View Article Sources
- Net Working Capital: What It Is and How to Calculate It – CRM.org
- Working capital in valuation – NYU Stern School of Business
- Is Lack of Capital the Real Problem? – The Sam M. Walton College of Business
- Cash and Working Capital Management in the Corona crisis – The European Association of Corporate Treasurers