Functions of a Central Bank
The modern banking system is two tiered. This means that at the bottom there are commercial banks i.e. the banks that we interact with on a day to day basis. They are then managed by a central bank which forms the next level in the hierarchy. The modern banking system provides central banks with considerably […]
Extrapolation: The Root Cause behind the Bubbles
They say that there is no smoke without fire. This is true of many things and one of them is asset bubbles. It is true that all asset bubbles begin their initial upward movement based on some genuinely good positive news. However, somewhere along the way, the amount of smoke far exceeds the underlying fire […]
Israel Economic Crisis: 1983
The Israeli bank crisis of 1983 rocked the Middle Eastern financial world. The Israeli economy was believed to be strong and has been able to navigate many wars since its inception in 1948 without breaking down. However, in 1983, the economy faced major shocks even in the absence of any major war or political upheaval. […]
The Economics of Sports Leagues
The discipline of economics is generally valid for all industries across the world. This is because the basic fundamental economic principles of demand, supply, and free market are applicable to almost all industries in the world. There are only a few industries where these economic principles are not really applicable. The sporting industry is one […]
The World without Bankruptcy Laws
Bankruptcy is one of the natural states which a company may find itself in. Entrepreneurship is primarily about taking risks. When companies take risks, some of them succeed, whereas others fail. Hence failure is a natural part of the business. However, many critics of bankruptcy laws believe that there isn’t a need for an elaborate […]
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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