Working capital is defined as a process when a company has all those necessary funds to meet its daily financial needs.
It’s obvious, that a sustainable firm must have enough funds to cover its financial obligations because, otherwise, the company will go bankrupt and will be forced to close.
According to the working capital formula (Working Capital = Available funds – day to day financial obligations), it’s crystal clear that if the working capital is negative, the company won’t have enough funds to meet the financial minimum.
Consequently, the risk of the business closed highly increases.
This is one of the interpretations of the negative working capital that isn’t 100% true.
The other interpretation of the negative working capital explains that negative working capital won’t necessarily have a disastrous outcome.
The accounting working capital formula (Working Capital = Current Assets – Current Liabilities), is the flawless argument of statement above.
As an absolute rule of funders, each of them wants to see a positive working capital. Such situation gives them the possibility to think that your company has more than enough current assets to cover financial obligations.
Though, the same can’t be said about the negative working capital. A large number of funders believe that businesses can’t be sustainable with a negative working capital, which is a wrong way of thinking.
Though, in order to run a sustainable business with a negative working capital it’s essential to understand some key components.
- Approach your suppliers and persuade them to let you purchase the inventory on 1-2 month credit terms, but keep in mind that you must sell the purchased goods, to consumers, for money.
- Effectively monitor your inventory management, make sure that it’s often refilled and with the help of your supplier, back up your warehouse.
Furthermore, big companies like McDonald’s, Amazon, Dell, General Electric and Wal-Mart are giants with negative working capital.
In order to understand the depth of the negative working capital concept, let’s discuss how exactly are these companies operating.
Note, that negative working capital is a sign of effective business managerial. In other words, the concept can be explained differently, when the business is being financed by its consumers.
Negative Working Capital: Company Examples
McDonald’s – The restaurant business is the most common place for finding negative working capital and McDonald’s is one of the most recognized brands today that had a negative working capital of $698.5 million between 1999-2000 years.
Amazon – Another fine example of negative working capital is Amazon Inc. (Amazon.com). The reason why these companies succeed with this strategy is that consumers pay upfront and the company has no problem in raising money.
Furthermore, the trick is that such businesses sell their products to customers even before actually paying for them.
Wal-Mart – Just like Amazon, Wal-Mart sells its products before paying for it. For instance, let’s discuss the Wal-Mart and Warner Bros. case.
When Wal-Mart ordered 500,000 copies of DVD from Warner Brothers, the deal was that Wal-Mart had to pay them within thirty days. Now, imagine that in 23 days Wal-Mart had already shipped, delivered to shops and sold every single copy they have ordered.
Obviously, Wal-Mart has already made a huge profit before paying Warner Brothers their money. So, as long as a company pays its debts/financial obligations on time, negative working capital can do no harm.
Dell Computers – The famous case study of Dell Computers shows that this strategy allowed the company to collect upfront payments from the customers, which also helped them to gain a competitive advantage over their rivals.