Is Negative Working Capital Always Bad?
As the summary of working capital
rightly says, WC is the difference between current assets and current liabilities. It shows the liquidity position of a company. This means that it depicts the operational capability of a company; its ability to perform day-to-day operating activities.
Positive, Neutral, and Negative Working Capital
WC could be positive, neutral, or negative. Positive working capital
is normally good news for a company. It means a company has the excess cash it needs for its day-to-day operating activities. Neutral working capital
is normally still a no worry situation for a company because the company has just enough cash or current assets for its day-to-day operating activities. But negative working capital
normally indicates a tough time to a company, because it means the company has a shortage of cash for meeting its day-to-day obligations to run the operations.
As we have seen, a negative working capital balance occurs when a company's current liabilities are greater than its current assets, it shows that the company cannot fulfill its day-to-day obligations. A negative working capital balance represents the weak liquidity position of a company.
Example of negative Working Capital
Assume a growing online retail store, "Happy Buy" maintains low inventory levels. Following is the balance sheet for the year 20XX of the company.
Happy Buy's total current assets are €20,000 and its total current liabilities are €25,000.
Working Capital = Current Assets – Current Liabilities
= €20,000 - €25,000
= - €5,000
Happy Buy is maintaining negative working capital, which indicates that the company might not be able to meet its current obligations.
Is Negative Working Capital ALWAYS Bad?
Let's find out if negative working capital is necessarily a bad sign for this company.
Normally negative working capital is not good or ideal because it is representing a weak liquidity position of a company. But sometimes, such as for growing companies like Happy Buy, maintaining a negative working capital position could be perceived as a a good sign because it shows that the company is quickly generating cash by collecting its receivables faster and delaying supplier payments. This means that the company is financing its day-to-day business operations by using its customers' and suppliers' money.
Microsoft has reported year over year negative working balance from 1999 to 2020. Amazon, Microsoft, and Walmart are also maintaining a negative working capital balance by things like collecting cash-upfront payments, applying robust credit collection policies, and stretching vendor payments time.
Remember it is really important to manage negative working capital well and efficiently, because any mismanagement or inefficient handling in such situation will lead to serious financial and/or business continuity issues.