What Does
Negative Working Capital Mean?
Negative working capital is when a company’s current liabilities exceed its current assets. This means that the liabilities that need to be paid within one year exceed the current assets that are monetizable over the same period.
A buyer usually considers negative working capital in a target as detrimental because it signifies additional capital that will be required to run the business after closing. A buyer actually prefers to see a working capital ratio of 1 to 1.5 times, which means there is at least one dollar of current assets for every dollar of current liabilities. This assures the buyer that the company can generate sufficient cash over the short term to cover supplier and payroll obligations.
Divestopedia Explains Negative Working Capital
Smart buyers will look for a high net working capital ratio if the business model requires a long working capital carry. This carry means that there may be a much longer period to convert receivables to cash than it takes to pay accounts payable.
That being said, there are some businesses in which negative working capital is a positive. The famous case study is Dell Computers, which had negative working capital as a result of its business model for years, allowing it to collect cash up-front, but pay suppliers later. Similar situations that result from a competitive advantage are more the exception than the rule, but they show that negative working capital can be a positive attribute in some cases.