When a companies current liabilities exceed its current assets, the company is said to have Negative Working Capital.
At the surface, having more current liabilities then current assets may be considered a bad thing, but a negative working capital scenario is not always bad.
In fact, it is common in certain industries.
Broadly, there are two instances when a company may face a negative working capital scenario.
First, the company could genuinely be going through a crisis.
The crisis may have arisen due to mismanagement or due to certain factors out of its control. As a result, the company may have accumulated more bills (current liabilities) then the resources available to pay for them (current assets). If not managed quickly, this scenario could spell financial disaster.
In the second case, a company may have a negative working capital by design.
Traditionally, the belief of management and investors alike was that a company must always have enough current assets on hand (especially cash) and keep it's liabilities to a minimum.
But, a company operating under the negative working capital model operates very differently than its traditional counterparts.
In a successfully planned and implemented working capital model, a business is able to generate cash so quickly that it can sell its products to the customers BEFORE it has to pay bills to its suppliers.
It then uses the 'fast cash' generated by quick sales to expand its business.
The Balance Sheet of a company in such a case shows a higher amount of current liabilities as opposed to current Assets.
If done effectively for a substantial period of time, many investors view this as a company using the customers/suppliers money to grow. If managed properly, this growth is better for the company then its alternative, which is bank financing.
These corporate giants have used their brand power, size, and market dominance effectively to collect cash from their customers first while having great flexibility in payments which they make to suppliers.
For the analysts and accounting geeks out there. Take care not to overthink the liquidity ratio calculations such as the current ratio and quick ratio for companies using the negative working capital model.
The standard ratio criteria which apply to most businesses do not apply to a business using this model.
For example, if you usually consider 2x as a good current ratio for a traditional business, a business following the negative current ratio model will not fit into this criteria but may not necessarily be a bad business.
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