Working capital can be negative if a company's current assets are less than its current liabilities. Working capital is calculated as the difference between a company's current assets and current liabilities. If a company's current assets substantially decrease as a result of a large onetime cash payment, for example, or current liabilities increase due to significant credit extension resulting in an increase in accounts payable, its working capital may turn negative.
Working Capital
Working capital can affect a company's longerterm investment effectiveness and its financial strength in covering shortterm liabilities. Working capital represents what a company currently has to finance its immediate operational needs, such as obligations to its vendors for extending credit on purchases of various goods and services to be used in the production process, inventory, cash balance and accounts receivable. Prepaid expenses are also part of working capital. When conducting valuations, certain investment professionals consider adjusted noncash working capital that does not include cash and cash equivalents, shortterm investments, and any loans and debt payments coming due within a year.
Working capital can be viewed as net total current assets, but the netted amount may not always be a positive number. It can be zero or even negative. As a result, different amounts of working capital can affect a company's finances in different ways.
Positive Working Capital
When a company has more current assets than current liabilities, it has positive working capital. Having enough working capital ensures that a company can fully cover its shortterm liabilities as they come due in the next 12 months. This is a sign of a company's financial strength. However, having too much working capital in unsold and unused inventories, or uncollected accounts receivables from past sales, is an ineffective way of using a company's vital resources.
The additional funds parked in inventories or receivables are not financed by shortterm liabilities but rather longterm capital, which should be used for longerterm investments to increase investment effectiveness. Therefore, the key is to maintain an optimal level of working capital that balances the needed financial strength with satisfactory investment effectiveness. To accomplish this goal, working capital is often kept at 20% to 100% of total current liabilities.
Zero Working Capital
When a company has exactly the same amount of current assets and current liabilities, there is zero working capital in place. This is possible if a company's current assets are fully funded by current liabilities. Having zero working capital, or not taking any longterm capital for shortterm uses, potentially increases investment effectiveness, but it also poses significant risks to a company's financial strength. Certain current assets may not be easily and quickly converted to cash when liabilities become due, such as illiquid inventories. Keeping some extra current assets ensures that a company can pay its bills on time.
Negative Working Capital
Negative working capital is closely tied to the concept of current ratio, which is calculated as a company's current assets divided by its current liabilities. If a current ratio is less than 1, the current liabilities exceed the current assets and the working capital is negative.
If working capital is temporarily negative, it typically indicates that the company may have incurred a large cash outlay or a substantial increase in its accounts payable as a result of a large purchase of products and services from its vendors. However, if the working capital is negative for an extended period of time, it may be a cause of concern for certain types of companies, indicating that they are struggling to make ends meet and have to rely on borrowing or stock issuances to finance their working capital.
The amount of a company's working capital changes over time as a result of different operational situations. Thus, working capital can serve as an indicator of how a company is operating. When there is too much working capital, more funds are tied up in daily operations, signaling the company is being too conservative with its finances. Conversely, when there is too little working capital, less money is devoted to daily operations – a warning sign the company is being too aggressive with its finances.

What can working capital be used for?
Find out what working capital is used for, including how to calculate this financial metric by subtracting current liabilities ... Read Answer >> 
What does a low working capital ratio show about a company's working capital management?
Find out the significance of working capital management for a company and look at the working capital ratio analysts use ... Read Answer >> 
Why working capital management matters
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Can a company's working capital turnover ratio be negative?
Learn how the working capital turnover ratio turns negative as a result of a company's negative working capital when current ... Read Answer >> 
Can working capital be too high?
Learn more about the working capital ratio, and understand how an excessively high ratio can be considered a negative in ... Read Answer >> 
How do you calculate working capital?
The formula for calculating working capital is straightforward, but lends great insight into the shorterterm health of a ... Read Answer >>

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