The most significant advantage of negative working capital (NeWC) is the holiday from bank funding. It saves the interest cost by getting funds from suppliers for current assets. It may also mean that the company is a cash-rich company whose operating cycle is fast. Therefore, the investment in finished goods is converted to cash before the due date of payment to suppliers. Let us see in detail the advantages of negative working capital.
Negative working capital (NeWC) is the negative difference between the current assets and current liabilities. It is the negative value of NWC. It is possible when current liabilities are more than current assets. This also implies that the current liabilities finance the whole of current assets and a portion of fixed assets. On the other hand, it may be understood that the portion of current liabilities other than current assets is invested in short-term investments to earn interest from them.
Advantages/Benefits of Negative Working Capital
It is not always bad to have negative working capital. Many giant companies with established brands have negative working capital because they can bargain very well with their suppliers. They have the muscle power of bulk demand.
Low Cost of Funding Current Assets
The first thing that would come to our mind is the interest cost of funds if funded by banks. It is because trade credit has no explicit interest cost. The suppliers provide the funds and the time limit to pay is also flexible to a great extent. This will depend on company to company and supplier to supplier.
Cash Richness and Earnings from Investments
Companies having negative working capital may not always have fixed assets financed by current liabilities, i.e., suppliers.
Some companies may be smart enough who, on one side, negotiate hard with the suppliers to get credit and, on the other side, collect money from the customer faster. The money received from the customer is not paid to the supplier but is invested in short-term investments to earn interest. These companies save the interest cost of working capital and earn some interest out of investments.
Must for Some Industries
Take the example of companies like Amazon, eBay, etc. They purchase goods on credit but sell the goods in cash, and their inventory movement is also fast. The shelf life of the product is also not long. For such companies, it is obvious to have negative working capital. On the contrary, if the management cannot achieve negative working capital, they would be considered inefficient. Similar is the case of retailers who purchase on credit but sell in cash. They also can develop free cash. Telecom companies are famous for having NeWC.
Also, read the Disadvantages of Negative Working Capital.