1he account|ng formu|a for work|ng

cap|ta|
Powever Lhere ls anoLher lnLerpreLaLlon of worklng caplLal where a negaLlve resulL
would noL mean such a dlsasLrous ouLcome 1hls ls found ln Lhe accounLlng deflnlLlon
of Lhe Lerm worklng caplLal whlch can also be expressed as a formula
1he key elemenLs of Lhls formula are Laken from Lhe flnanclal sLaLemenLs of
Lhe buslness and ln parLlcular Lhe 8alance SheeL (also called Lhe SLaLemenL of
llnanclal oslLlon) 1he key elemenLs are
Current assets are lLems of economlc value LhaL can be converLed lnLo
cash qulLe qulckly ln Lhe accounLlng perlod (usually 13 monLhs) 1hese
lLems Lyplcally lnclude cash lnvenLory accounLs recelvable (le whaL
cusLomers owe Lo Lhe buslness)
Current ||ab|||t|es are monles LhaL a buslness owes Lo exLernal parLles (noL
owners) and are due for paymenL wlLhln Lhe currenL accounLlng perlod
(usually wlLhln Lhe nexL 12 monLhs) 1hese lLems are Lyplcally accounLs
payable (le whaL Lhe buslness owes Lo suppllers) plus oLher payables llke
lncome Lax or councll raLes
1he account|ng formu|a for work|ng
cap|ta|
W s a rule flnanclers llke Lo see a poslLlve worklng
caplLal accordlng Lo Lhls accounLlng formula
equlvalenL Lo Lhe slze of Lhe currenL llablllLles le
meanlng LhaL Lhe buslness has Lwlce Lhe amounL
of currenL asseLs as lL has currenL llablllLles 1hls
ouLcome from Lhe accounLlng worklng caplLal
formula glves flnanclers confldence LhaL your
buslness wlll have more Lhan sufflclenL worklng
caplLal Lo meeL lLs flnanclal obllgaLlons as Lhey
become due
ccounLlng calculaLlon
now whlle Lhls ls Lhe rule Lhere are some buslnesses LhaL can remaln
susLalnable whlle havlng a negaLlve worklng caplLal accordlng Lo Lhe
accounLlng formula LeLs Lake a look aL Lhe followlng example (noLe
1hese LoLals would be Laken from Lhe balance sheeL)
Cash $10000
lnvenLory $100000 (leLs say represenLlng 4 monLhs worLh of
sales)
ccounLs 8ecelvable $40000
ccounLs ayable $70000
1axes ayable $3000
pplylng our accounLlng worklngcaplLal formula we geL
Worklng caplLal (10000 + 100000 + 40000) (70000 + 3000) +
poslLlve $73000
ccounLlng calculaLlon
W 1hls ls Lhe resulL mosL flnanclers are looklng for because Lhe
buslness has Lwlce as much currenL asseLs as currenL
llablllLles 8uL leLs suppose LhaL a slmllar buslness buys
on credlL from suppllers buL sells for cash le no
accounLs recelvable LeLs also suppose LhaL Lhls
buslness sLlll needs $10000 cash on hand aL all Llmes Lo
pay suppller accounLs as Lhey become due buL has
found a way Lo operaLe on [usL one monLhs supply of
lnvenLory le $100000/4 $23000 pplylng Lhe
accounLlng worklng caplLal formula Lo Lhls buslness we
see Worklng caplLal (10000 + 23000) (70000 +
3000) negaLlve $40000
W 1hls buslness sLlll has Lhe cash funds Lo pay lLs bllls as
Lhey become due yeL Lhe accounLlng worklng caplLal
number ls a negaLlve amounL So lL ls posslble Lo have
negaLlve worklng caplLal accordlng Lo Lhe accounLlng
formula and sLlll have a susLalnable and vlable buslness
buL Lhere are a few keys ln dolng so
W 8uy lnvenLory on long daLed credlL Lerms (30/60 days) from your
suppllers buL sell Lhe lnvenLory for cash Lo your cusLomers (Cash on
uellvery CCu)
W 8e very efflclenL wlLh your lnvenLory managemenL Carry Lhe leasL
amounL of lnvenLory posslble and reflll ofLen ?ou could also sell only
from a dlsplay lLem and have your suppller warehouse your backup
reserve sLock
W ln Lhls regard negaLlve worklng caplLal ls a clever
flnanclng sLraLegy because Lhe buslness ls acLually uslng
lLs suppllers worklng caplLal as lLs own 1he besL
example of a buslness LhaL ls able Lo operaLe on a
negaLlve worklng caplLal basls ls Macuonalds
-egat|ve Work|ng Cap|ta| Can 8e Good
Somet|mes
Some companles can generaLe cash so qulckly Lhey
acLually have a negaLlve worklng caplLal 1hls ls
generally Lrue of companles ln Lhe resLauranL buslness
(Mcuonalds had a negaLlve worklng caplLal of $6983
mllllon beLween 1999 and 2000) mazoncom ls
anoLher example 1hls happens because cusLomers
pay upfronL and so rapldly Lhe buslness has no
problems ralslng cash ln Lhese companles producLs
are dellvered and sold Lo Lhe cusLomer before Lhe
company ever pays for Lhem
some exLremely efflclenL companles such as
WalMarL can have negaLlve worklng caplLal
because Lhey sell goods on Lhe shelf fasLer Lhan
Lhey pay Lhe vendor for Lhe merchandlse
DndersLand how a company can have a
negaLlve worklng caplLal?
W Warner 8roLhers / WalMarL example When WalMarL
ordered Lhe 300000 coples of a uvu Lhey were
supposed Lo pay Warner 8roLhers wlLhln 30 days WhaL lf
by Lhe slxLh or sevenLh day WalMarL had already puL Lhe
uvus on Lhe shelves of lLs sLores across Lhe counLry? 8y
Lhe LwenLleLh day Lhey may have sold all of Lhe uvus ln
Lhe end WalMarL recelved Lhe uvus shlpped Lhem Lo
lLs sLores and sold Lhem Lo Lhe cusLomer (maklng a proflL
ln Lhe process) all before Lhey had pald Warner 8roLhers!
lf WalMarL can conLlnue Lo do Lhls wlLh all of lLs
suppllers lL doesnL really need Lo have enough cash on
hand Lo pay all of lLs accounLs payable s long as Lhe
LransacLlons are Llmed rlghL Lhey can pay each blll as lL
comes due maxlmlzlng Lhelr efflclency
1he boLLom llne
W negaLlve worklng caplLal ls a slgn of managerlal
efflclency ln a buslness wlLh low lnvenLory and
accounLs recelvable (whlch means Lhey operaLe on
an almosL sLrlcLly cash basls) ln any oLher slLuaLlon
lL ls a slgn a company may be faclng bankrupLcy or
serlous flnanclal Lrouble ?ou can Lell lf Lhls ls Lhe
case by comparlng a companys accounLs payable Lo
Lhe LoLal lnvenLory on Lhe balance sheeL
8uy|ng a Company for Iree
W lf you can buy a company for Lhe value of lLs
worklng caplLal you essenLlally pay noLhlng for Lhe
buslness Coodrlch example Lhe company has $933
mllllon ln worklng caplLal 1here are currenLly 1019
mllllon shares ouLsLandlng whlch means each share
of Coodrlch sLock has $916 cenLs worLh of worklng
caplLal lf C8s sLock was Lradlng for $916 you
would baslcally be purchaslng Lhe sLock for free
(paylng $1 for each $1 Lhe company had ln lLs
checklng accounL lnvenLory eLc) ?ou would pay
noLhlng for Lhe companys flxed asseLs (such as real
esLaLe compuLers bulldlngs) and earnlngs
-egat|ve Work|ng Cap|ta| Can 8e a Good 1h|ng for
n|gh 1urn 8us|nesses
W Companles LhaL have hlgh lnvenLory Lurns and do buslness on a cash
basls (such as a grocery sLore) need very llLLle worklng caplLal 1hese
Lypes of buslnesses ralse money every Llme Lhey open Lhelr doors Lhen
Lurn around and plow LhaL money back lnLo lnvenLory Lo lncrease sales
Slnce cash ls generaLed so qulckly managemenLs can slmply sLockplle Lhe
proceeds from Lhelr dally sales for a shorL perlod of Llme lf a flnanclal
crlsls arlses Slnce cash can be ralsed so qulckly Lhere ls no need Lo have
a large amounL of worklng caplLal avallable company LhaL makes heavy
machlnery ls a compleLely dlfferenL sLory 8ecause Lhese Lypes of
buslnesses are selllng expenslve lLems on a longLerm paymenL basls
Lhey canL ralse cash as qulckly Slnce Lhe lnvenLory on Lhelr balance
sheeL ls normally ordered monLhs ln advance lL can rarely be sold fasL
enough Lo ralse money for shorLLerm flnanclal crlses (by Lhe Llme lL ls
sold lL may be Loo laLe) lLs easy Lo see why companles such as Lhls musL
keep enough worklng caplLal on hand Lo geL Lhrough any unforeseen
dlfflculLles