Negative Working Capital: Good or Bad?

Net working capital (NWC) is the difference between current assets and current liabilities in a company’s balance sheet.

When the value of the current liabilities exceeds the value of the current assets, the company has a negative net working capital.

In this post, we’ll explore whether this is good or bad.

Let’s dive in:

Understanding Net Working Capital

Let’s understand the two categories that make up the calculation of net working capital—current assets and current liabilities.

Current assets include cash or assets the firm will convert into cash within one year. This category contains the following:

• Cash, and short-term liquid low-risk investments that can be easily sold for cash (for example, government bonds maturing within a year).
• Accounts receivable: Money customers owe to the company for buying goods and services with trade credit, which is when they are allowed to pay for the products later.
• Inventories of the goods and services the company sells, including the materials necessary to build those products and products that are not finished yet.
• Prepaid expenses (such as rent or insurance paid in advance).

Current liabilities include money the company owes and will pay off within one year. For example:

• Money the company owes to suppliers for goods and services purchased with trade credit (accounts payable).
• Short-term debt and loans the company expects to repay the bank within one year.
• Salaries and taxes the company owes but hasn’t paid yet.
• Money it has received for products that it has not delivered yet.

Net working capital is calculated through the following formula:

Working Capital = Current Assets – Currents Liabilities

This number tells you how much capital is available in the short term to run the business. It measures the liquidity of the business.

Depending on what you want to evaluate, you may want to include or exclude a couple of elements from the calculation.

I’m using the terms net working capital and working capital interchangeably for this article, and I’m considering it follows the formula above. However, other people may consider the two are different:

Net Working Capital = (Current Assets – Cash and equivalents) – (Current liabilities – Short-term debt and loans)

They exclude non-operational items like cash and debt. Why? Because these have little to do with the company’s daily operations to bring its products and services to the market.

Whichever way you choose, in general, a negative number is a bad sign. It means the company does not have enough resources in the short term to pay off its debts.

However, there are exceptions.

Negative Net Working Capital: Good or Bad?

If Current Assets > Current Liabilities, you have positive working capital.

If Current Assets < Current Liabilities, you have negative working capital.

Which one is better?

Both can be good.

However, most times, positive working capital is better. Here’s why:

Working capital is the value left over after all your short-term debts are met by your available sources of cash or cash equivalents.

The obligations the company has in the current liabilities category are expected to be paid within a year. With what cash? The cash in current assets.

If there’s not enough cash, we have a problem.

It could mean there’s not a lot of demand for the company’s products. As result, the company doesn’t have a lot of clients.

Another reason for low accounts receivable is that clients pay immediately, which is good (more on this later).

This has to do with the difference between cash flow and income. Part of the income you see on a company’s profit and loss statement is not actual cash entering the company. It’s just an agreement made with customers, as you allow them to pay for stuff later. When they pay immediately, the money never touches accounts receivable, justifying the low value of this category.

But if the company doesn’t have a lot of clients, cash is low, and it isn’t investing in growth opportunities, it’s a bad sign.

A negative working capital business can also have excessive short-term debt. Whether it’s banks or suppliers, the company doesn’t have enough cash to liquidate those debts. As a result, the balance owed to them grows and grows.

These are the main disadvantages of negative working capital. But there are cases where negative net working capital is a good thing:

When Negative Working Capital is Good

It is not common, but negative working capital can be a good thing. This happens in a few industries. Here are some industries with negative working capital:

• Large retailers
• Grocery stores
• Restaurants

You will only find businesses that sell directly to consumers in this category. Giving credit to customers and allowing them to receive the goods now and pay later is more common when you’re selling to other businesses.

With this in mind, remember:

The balance sheet shows obligations and rights yet to be paid. Customers may not pay for the goods they purchase immediately. While sales are immediately counted as earnings, the company does not receive any cash until the customers actually pay.

This means if customers pay immediately, the money will go straight to cash without ever being recorded in accounts receivable. Then, if you use that cash to grow your business, the value of current assets will go down.

On top of that, inventory will go down as you deliver the goods to your customers, which will further reduce the value of current assets.

Contrast this with the fact your suppliers allow paying later. You’re receiving the goods and putting them up for sale. You sell them for a profit before any cash has even left your company to pay the suppliers. This future obligation adds to the current liabilities.

With this in mind, if we look at net working capital and consider only the operational elements of current assets (exclude cash) and liabilities (exclude loans), we want it to be as low as possible. In this case—and if the company has enough cash to cover short-term debt—we prefer a negative NWC over an increase in NWC.

Here’s why:

• An increase in accounts receivable represents additional lending by the company to its customers, and it reduces the cash available to the firm.
• Accounts payable represent borrowing by the company from its suppliers. This borrowing increases the cash available.
• An increase in inventory is a cash outflow to the company. Why? Because the cost of goods is only included in net income when the goods are actually sold.

In this case, a negative change in working capital is good, as it means more cash for the company and it implies that:

• The business is efficient at collecting cash from its customers.
• The business has negotiating power with its suppliers.
• It has a lot of demand for its products, as inventory turnover is high.

Now that we know the good reasons for negative working capital, let’s look at a real-life example of this:

Negative Working Capital Example

Walmart is an example of a negative working capital business with success.

Walmart had negative working capital of more than $2 billion at the end of 2021, as it had current assets of over $90 billion and current liabilities of over $92B.

This is one of the many established companies with negative working capital.

Let’s think about why this happens. It boils down to this:

Walmart is a big retailer. Its customers pay them immediately. But they don’t pay their suppliers immediately.

For example, say Walmart buys some oranges and agrees to pay the farmer in 30 days. The farmer agrees and ships the oranges to the store. A couple days later the oranges are on the shelves. Few weeks later? They’re all sold.

In this case, Walmart sold the oranges to the customer (making a profit in the process), before the company paid the farmer.

They have negotiating power with their suppliers because Walmart is likely the biggest customer for any company or farmer they buy from. And no business wants to lose its biggest customer. As result, they’re given more leeway on payment terms.

Now, if Walmart did nothing with the excess cash, it would be sitting pretty in its category—cash and cash equivalents. However, negative working capital means this is not the case and they’re investing in other areas.

Negative Working Capital FAQs

There you have it! Negative working capital is not always a bad thing. It largely depends on the industry the business is involved in.

Let’s briefly recap the main takeaways we’ve covered in this article: