Understanding Negative Working Capital

Q: What does negative working capital indicate?

It depends on the business. It can indicate a business has a high inventory turnover, meaning it’s able to sell off inventory before any amount is owed to the supplier. On the other hand, it can simply mean that the business itself is having difficulty receiving on-time payments from its customers.

Q: Is negative working capital typically a bad thing to have?

It depends on the business. Businesses that are mainly cash-only companies (retailers, restaurants, online retailers, and grocery stores, for example), often have negative working capital. However, a company can be in a high volume field and have negative working capital and be in financial danger. Negative working capital can be a good thing, but it can just as easily be a bad thing. It all depends on the business.

Q: Can working capital being too high be a problem?

Let’s restructure this question along the lines of whether a company can have too many assets (which can be liquidated). If a company has too many assets that it is not actively using, then it is possible for it to be an issue because it suggests operations are not operating at peak efficiency. Companies with too many assets should consider liquidating those assets and investing them in other ways.

What Negative Working Capital Is & What Causes It

Lauren WardUpdated April 9, 2023

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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

What is negative working capital? Negative working capital is when a company’s short-term liabilities are greater than its short-term assets. It’s easy to think that companies with negative net working capital would be at financial risk, but that’s not necessarily the case. There are many situations where having a negative working capital can actually work in a business’s favor. Many companies have and do use negative working capital to their advantage. Perhaps the most famous example is Walmart. As a retailer, most of Walmart’s products come from other suppliers. When it sells out of a product before paying the supplier, it’s in a state of negative working capital. Below we’ll provide a more in-depth negative working capital meaning, talk about when it usually occurs, and discuss its pros and cons for businesses.

What Is Negative Working Capital?

What does negative working capital mean? Can working capital be negative? Before we get into that, let’s first talk about working capital. Working capital is the difference between a business’s current assets and current liabilities. A current asset is an asset that can be easily converted to cash within a year, while a current liability is any debt that is expected to be repaid within a year (such as an account payable). Ideally, current assets should be greater than current liabilities, but, as with Walmart and other businesses, that’s not always the case. Negative working capital is when a company’s liabilities outnumber its assets, and it’s much more common than you may think. For example, restaurants, grocery stores, and retailers (both online and physical) are often in a state of negative working capital. Because they receive payment immediately for everything they sell, sold-out inventory means the value of their assets (the inventory) is lower than the upcoming bill. The big question is why cash is not considered a part of working capital once the inventory has been sold. There are two mindsets when it comes to working capital— one that includes cash, and one that does not. For our purposes we will exclude cash as an asset because cash does not generate revenue on its own (unlike short-term securities) and is therefore not an operating asset. Therefore, the formula we will be using is:Noncash Current Assets — Zero-interest Current Liabilities= Non-Cash Working Capital Recommended: Guide to the Working Capital Cycle

Positive Working Capital

Positive working capital is when a company has an abundance of assets compared to its liabilities. It's the opposite of negative net working capital and is usually a good place for a company to be in. Overall, it means that the company’s account receivables is more than its account payables. In order to be approved for most types of business loans, businesses need to have a positive working capital because many loans require assets as collateral. If the business is upside down on its debts vs its assets, it may have trouble getting approved, but there are many factors that lenders look at. However, consider this: too much positive working capital can sometimes be a bad thing. If assets are sitting somewhere and not helping the business grow and generate further revenue, then it’s possible they could be better used elsewhere to fuel the company’s next phase of development. To be competitive in today’s market, leveraging growth for healthy, steady business expansion is often essential.Recommended: Small Business Working Capital Loans

Zero Working Capital

Zero working capital is when a company’s assets are the same amount as its current liabilities. This typically occurs when all of a company’s assets are funded by liabilities or debt instruments. A company with zero working capital may be in financial jeopardy if those assets are what is known as illiquid inventories. An illiquid inventory is one that is not easily sold off. Should a debt be due, the zero working capital company may not be able to settle its debt, which is why it’s always a good idea to have a few extra liquid assets on hand. Recommended: What Happens if You Fail to Repay a Business Loan?

How Negative Working Capital Arises

The ideal scenario: A company orders a lot of inventory from a supplier and sells out of the inventory before the bill is due. When suppliers offer inventory on credit or delayed payment (meaning payment is not immediately required), it’s easy to get into a negative working capital situation.Companies able to do this with all of their suppliers don’t need to stress too much about how much cash they have on hand for all of their account payables. As long as they can easily pay each bill by the time it’s due, as well as cover their day-to-day expenses (such as utilities and salaries), then having negative working capital is fine.

Pros and Cons of Negative Working Capital

Pros of Negative Working Capital	Cons of Negative Working Capital
• Can aid in expedited growth• Money can be used for other investments and opportunities	• Businesses need a strong understanding of their cash flow• If business does not proceed as anticipated, companies could run out of money to cover the basics, such as payroll and utilities, which could unexpectedly lead to bankruptcy

When Is Negative Working Capital Good vs Bad?

Is negative working capital bad? As discussed, negative working capital can either be good or bad. Let’s talk about why.

Good Negative Working Capital

Negative working capital is a good thing when companies are able to sell their inventory faster than their suppliers expect payment. When this occurs, the vendor is essentially financing part of the company’s operating expenses — almost like a zero-interest loan.When it’s done well, sudden opportunities can be taken advantage of that may help a business expand or grow in unexpected ways.

Bad Negative Working Capital

As soon as a company is unable to pay its operational costs or suppliers on time, negative net working capital becomes bad. Even if a company may have utilized negative working capital in the past without issues, a hiccup in sales can hurt operations fast. COVID-19, of course, wounded most businesses in some way, but restaurants were some of the first casualties because many routinely operated with negative net working capital. When cash flow suddenly changed, and the daily juggle of capital was affected, many had no choice but to close their doors for good. However, it doesn’t have to be something dire. Any change in daily operations can affect a company with NWC. Legal expenses or lengthy repairs can hurt a company with negative working capital more than others.

Which Industries Typically Have Higher Negative Capital?

Companies with high inventory turnover often have negative working capital. Restaurants, retailers, and grocery stores often have a negative net working capital.

Strategies for Dealing With Negative Working Capital

To stay on top of negative working capital, business owners need to:

Fully understand the flow of cash within their company. For this, analyzing monthly, quarterly, and yearly income statements can help.
Keep track of account receivables.
Analyze how long it takes to completely sell through inventory batches.
Optimize billing cycles— meaning business owners should space out expenses to match estimated sales.

Negative Working Capital Example Calculation

Here’s a negative working capital example: A gaming retailer buys $1.5 million worth of the latest console directly from the manufacturer. It sells every console within the first day, but doesn’t have to pay its bill for the next 45 days. It now suddenly has a greater amount of liabilities than it does assets. Meanwhile, it can use its sudden influx of cash to invest in other areas to grow. Recommended: How to Apply for Business Loans

The Takeaway

Negative working capital is when a company’s current liabilities outweigh its current assets. Because cash does not directly generate revenue, it is not considered an asset. Negative net working capital is fine as long as a company is able to pay its operational expenses and suppliers on time. If it is unable to, its long-term financial health may be in jeopardy.

3 Small Business Loan Tips

Online lenders generally offer fast application reviews and quick access to cash. Conveniently, you can find recommended small business loans by using Lantern by SoFi.
Traditionally, lenders like to see a business that’s at least two years old when considering a small business loan.
If you need to borrow money to cover seasonal cash flow fluctuations, a business line of credit, rather than a term loan, provides the flexibility you likely need.

Frequently Asked Questions

What does negative working capital indicate?

Is negative working capital typically a bad thing to have?

Can working capital being too high be a problem?

Photo credit: iStock/JLco - Julia Amaral

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About the Author

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.

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