Negative working capital (NeWC) is the surplus of current liabilities over the current assets. It is regarded as bad if it disturbs the business operating cycle of a company more or less consistently. It may be considered good if a company has NeWC without disturbing the operating cycle consistently. Such companies may include Walmart, Amazon, etc., which buys on credit and sells in cash and the inventory turnover is also fast, almost instantaneous. Let us see about the disadvantages of negative working capital.
Disadvantages of Negative Working Capital (NeWC)
Here, we will not talk about the exceptions and will discuss the disadvantages of negative working capital in the normal course of business.
Companies with negative working capital are using the money of creditors to finance current assets and a part of fixed assets. Buying fixed assets with this money can pose some financial trouble anytime.
When the payment of accounts payable is due, the company may fall short of cash. And it will be challenging to sell the fixed assets where the money from current liabilities is stuck. This will lead to bankruptcy risk for the company.
Lower Rating Resulting in Higher Interest Rate
Business with NeWC is struggling to make payments to the creditors and cannot collect money or sell the lying stock. The credit rating of such companies is bound to go down—lower rating results in higher interest rates charged by the banks.
Growth Opportunities Missed
Negative working capital effectively means no working capital. No growth crops up without money. Without spare working capital, a company cannot take up any seasonal and special growth opportunities. This is how companies with NeWC miss the growth opportunities.
Investors and Bankers don’t find it worth Investing
Positive working capital is a sign indicating growth and profitability in the business. Also, negative working capital implies overfunding by suppliers. A banker or investor would not find it worth investing in such a company in both situations.
Lost Trade Discount
Normally, if a company has NeWC, it is understood that the accounts payables are not paid on time, which will vanish the trade discount, which is only allowed if paid within a certain period.
Bad Financial Reputation
Not only does a company having NeWC lose on trade discounts, but it also loses its financial reputation in the market.
Non-paying and late paying both are crimes for supplier relationships. A bad financial reputation is a slow poison, and it reaches a point when all suppliers in the market stop releasing credit to the company. How will the company do business without suppliers supplying raw materials or goods?
Winding Up Petition by Creditors
When the creditor’s concern changes from late payment to probably no payment, there are good chances that they may file a petition for winding up of the company for the sake of their hard-earned money.
Bad Fixed Asset Turnover
The fixed asset turnover ratio indicates how many sales are generated using the company’s fixed assets. The higher the sales generated using the fixed assets, the higher the ratio and the higher the leverage of using the fixed assets. Without working capital, it is not possible to push sales. This leads to inefficient use of the fixed assets also.
Also, read Advantages of Negative Working Capital.