Working capital represents the difference between a firm’s current assets and current liabilities. For well-run firms, managing working capital is simply a daily occurrence it can easily handle. For other firms, the way the process is handled can indicate financial distress.   

The impact of working capital changes are reflected in a firm’s cash flow statement. Specifically, the operating cash flow section of the cash flow statement details changes in its shorter-term working capital needs. A positive working capital figure (current assets are greater than current liabilities) means a cash inflow for the period measured. In contrast, a negative working capital position means the firm has spent more cash out than it brought in managing its working capital, or commitments, within a year. Analyzing changes in working capital can be important for any business, but is especially important for firms with seasonal or erratic cash flow needs. 

For instance, retailing giant Wal-Mart Stores Inc (WMT), like most retailers, spends a considerable amount of working capital prior to the all-important holiday selling season.

Looking at Wal-Mart’s 2013 quarterly cash flow statement (fiscal third quarter ended October) prior to the calendar fourth quarter, we can see that it spent nearly $7 billion (reflected as a cash outflow) on inventory. This contrasts sharply with the other three quarters. In its first and second quarters, spending on inventory was minimal and came in at $584 million (a cash inflow) and negative $15 million. In the fourth quarter, inventory decreased by a wide margin and brought in nearly $4.5 billion in working capital.

On the other side, Blockbuster, the video rental chain that went bankrupt, had a working capital situation that was much grimmer. In fiscal 2010, its change in accounts payable and accrued expenses totaled a cash outflow of nearly $250 million and it came following a reported loss of close to $600 million. At the time, cash on hand was only $190 million. With a negative working capital, the company was not able to meet its short-term obligations. Later that year, the firm filed for bankruptcy. 

The Bottom Line

Most of the time, a company’s working capital is simply a core part of its daily operations. But it can indicate financial problems, especially when working capital runs in the negative for an extended period of time.

At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.




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