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. If a company has NeWC without disturbing the operating cycle consistently, it may be considered good. Such companies may include Walmart, Amazon, etc who buys on credit and sells in cash and the inventory turnover is also fast almost instantaneous.
Table of Contents
- 1 DISADVANTAGES OF NEGATIVE WORKING CAPITAL (NeWC)
DISADVANTAGES OF NEGATIVE WORKING CAPITAL (NeWC)
Here, we will not talk about the exceptions and will discuss the disadvantages of NeWC in the normal course of business.
Companies with negative working capital are using the money of creditor to finance current assets as well as a part of fixed assets. Buying fixed assets with this money can pose some financial trouble anytime.
When the payment of accounts payable will be due, the company may fall short of cash and it will be difficult 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 payment to the creditors and not able to collect money or sell
the lying stock with it. 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 crop up without money. Without spare working capital, a company is not able to take up any seasonal and special growth opportunities. This is how companies with NeWC misses 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 over funding by suppliers. In both of the situations, a banker or investor would not find it worth investing in such a company.
Lost Trade Discount
Normally, if a company is having NeWC, it is understood that the accounts payables are not paid on time and that will definitely vanish the trade discount which is only allowed if paid within a certain period of time.
Bad Financial Reputation
Not only does a company having NeWC lose on trade discounts but also lose the financial reputation in the market.
Non-paying and late paying, both are crimes for supplier relationships. 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
Fixed asset turnover ratio indicates that how many sales are generated using the fixed assets of the company. Higher the sales generated using the fixed assets, higher will be the ratio and higher would be the leverage of the using the fixed assets. Without working capital, it is not possible to push the sales. This leads to inefficient use of the fixed assets also.