Strategic Finance and Competitive Advantage
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Structural Unemployment – Definition, Causes and Cure
In the previous article, we studied about frictional unemployment. We understood as to why frictional unemployment is a temporary situation caused by the workers own wishes. It is not a social evil and therefore should not be categorized as such. In this article, we will have a look at the second type of unemployment. This […]
Should There be Reservations in the Private Sector and the Alternatives for Social Justice
The Vexatious Issue of Reservations in the Indian Private Sector Every now and then, the vexatious issue of Reservations in the Private Sector crops up in India and more so, in the run up to the elections that are held every five years or less. This issue that polarizes Indian society and policymakers apart from […]
Why Dissatisfaction in Customers?
When the suppliers are unable to entertain customers or their business strategies fail to build a good relationship with customers, they probably end up with customers’ dissatisfaction. Their can be many reasons for the customers to become dissatisfied. Some of these reasons are: Taking example of India, most of the population here are vegetarian. They […]
Human Resource Information System (HRIS): Meaning, Evolution and its Features
In the contemporary scenario of modernization and globalization, organizations heavily rely upon technological advancement and innovation in the field of Information Technology. Advancements in the field of IT has opened up newer avenues for the organizations and provided a competitive advantage by using innovative and customized solutions. It has become an integral part of the […]
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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