Negative Working Capital

Definition - What does Negative Working Capital mean?

Negative working capital is the situation where a company's current liabilities exceed its current assets. This means that the liabilities of the company that need to paid within one year exceed the current assets 

Negative Working Capital

A buyer actually prefers to see a working capital ratio of 1.0 - 1.5x, which means there is at least one dollar of current assets for every dollar of current liabilities. This assures the buyer that the company can generate sufficient cash over the short run to cover  and supplier and payroll obligations. However, smart buyers will look for an even higher net working capital ratio . This carry means that there may be a much longer period to convert receivables to cash than it takes to pay accounts payable.

That being said, there are some businesses in which negative working capital is a positive. The famous case study is Dell Computer, which for years had negative working capital as a result of its business model that allowed it to collect cash up-front but pay suppliers later.

Such situations result from a competitive advantage are more the exception than the rule.

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.

When Wal-Mart ordered the 500,000 copies of a DVD, they were supposed to pay Warner Brothers within 30 days. What if by the sixth or seventh day, Wal-Mart had already put the DVDs on the shelves of its stores across the country? By the twentieth day, they may have sold all of the DVDs. In the end, Wal-Mart received the DVDs, shipped them to its stores, and sold them to the customer (making a profit in the process), all before they had paid Warner Brothers! 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.

Things to Remember

If the ratio is less than one then they have negative working capital. A high working capital ratio isn't always a good thing, it could indicate that they have too much inventory or they are not investing their excess cash.

Examples

1. McDonald's had a negative working capital of $698.5 million between 1999 and 2000). 
2. Amazon.com is another example.
3. Dell