Benefits of Buy Now Pay Later (BNPL)
Buy Now Pay Later (BNPL) is the latest buzzword in the retail industry. The media has been full of debates about the benefits and drawbacks of Buy Now Pay Later (BNPL) from the consumers point of view. However, when it comes to the point of view of the merchant or the seller, there has not […]
Why must corporations be taxed?
We live in a capitalist world today. This is the era of multinational corporations. Today, there are many companies that are more powerful as compared to entire nations. This is the reason that they sometimes lobby hard to avoid taxes. Many times, when these companies are in a dominant position, they even threaten governments that […]
Growing Perpetuity
We have seen that a perpetuity represents an infinite stream of future cash flows. However, we have also seen that as time passes the value of these cash flows constantly diminishes. $100 may be able to buy us quite a few goods today, but in 50 years time $100 will not be nearly as valuable […]
Gold vs. Bitcoin
Gold has always been the alternative asset class. Whenever people lose faith in the value of the stocks that they are holding or even in the value of any currency, they typically sell their holdings and invest the proceeds in gold. However, of late, Bitcoin has burst onto the scene. Gold is no longer the […]
The Future of Financial Modelling
Financial modeling is an intensive technology process. This means that at the present moment also, financial models use the latest technology in order to ensure that the most up to date results are available during the simulation. However, with the passage of time, technology is also advancing rapidly. Improvements like machine learning, robotic process automation, […]
Traditional financial analysts would consider a negative working capital i.e. having more current liabilities than current assets, a sign of imminent danger. This view was deep rooted in the belief that a company must always have sufficient cash on hands to meet its short term liabilities failing which the credit will dry up and the company will get into a lot of trouble.
However, of late negative working capital has actually become a norm in many industries such as retail. There are thriving businesses such as Wal-Mart that have based their entire business strategies around negative working capital. This paradigm shift in the opinion about negative working capital is what makes it an interesting subject to read further about. This article will provide more details.
As per traditional analysis, investors would look at the current ratio of a company with negative working capital with great concern. As the current assets will be less than the current liabilities, this would signal imminent danger to them. The current ratio of such a company would be less than 1. However as we will see it is more than healthy.
In some businesses like in retail, inventory is taken from the suppliers on sale or return basis. This has become the norm after big ticket retailers such as Wal-Mart pretty much control the shelf space which in turn controls what people buy.
Suppliers of Wal-Mart therefore find Wal-Mart in a commanding position and therefore are more than happy to extend liberal trade terms. These terms state that Wal-Mart must make the payment for the purchases in 45 days if they are able to sell the inventory. In case they are not able to sell it, the suppliers will be more than happy to take the goods back.
Wal-Mart while on one hand has negotiated a 45 day credit for itself, sells to customers on cash. Assuming a period of 10-15 days to actually sell the inventory, Wal-Mart still has one full month of interest free cash for itself. They can use this cash for their treasury operations or to fund future growth of their company. In case they fail to sell the goods within 45 days, they just return the inventory or get an extension.
Hence, a negative working capital scenario has become beneficial for many companies who meet their operating expenses out of interest free credit extended by the suppliers.
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