We’ve received a lot of positive feedback on the Cash Flow: It’s All That Matters series. So much so that we thought our readers would like a more regular installment of all things accounting.
The goal: Send weekly accounting lessons that you can read in less than five minutes.
We know learning about accounting is like watching paint dry. That’s why we’re breaking them into five minute bites.
Our first lesson: Working Capital Cycles
What Is Working Capital?
Working capital is your current assets minus current liabilities (CA – CL).
Current assets are things like:
- Cash in the bank
- Accounts receivables (money that needs collecting)
Current liabilities are things like:
- Accounts payable (bills you need to pay)
- Short-term debt
- Current portion of long-term debt
- Unearned revenue outstanding (similar to A/R)
Apple’s (AAPL) latest 10-K reported $163B in current assets and $106B in current liabilities. This gives us $57B in positive working capital.
Positive & Negative Working Capital
Working capital has two forms: positive and negative
Positive: You have excess cash to pay for the daily operations of the business (salaries, creditors, suppliers, rent, etc.).
Negative: You do not have current cash to pay for daily operations but instead use suppliers and customers to fund expenses.
The Pros & Cons of Positive & Negative Working Capital
There’s benefits and downsides to both types of working capital cycles. Let’s start with positive working capital:
- You have a good cash buffer for unexpected expenses
- Can fund growth and future opportunities with cash
- High working capital could be due to too much inventory or inability to reinvest in the business
Alright let’s shift to negative working capital:
- Fund operations through suppliers and customers
- Generate cash from customers before you have to pay your current liabilities
- Ideal for businesses with high turnover in product/sales
- Without growth, working capital eats away at profits
- Lose money if customers don’t pay on time (i.e., higher A/R)
- Doesn’t look good for bank funding/liquidity
Which Cycle Works Best?
The answer: it depends.
It depends on the industry you’re in and the growth trajectory of the internal business. Companies that enjoy negative working capital cycles include: Online retailers, grocery stores, restaurants and telecom companies (via financialexpress.com).
That wraps up this week’s accounting breakdown.
If you like this idea, let me know. If you hate it, still let me know. We’re always looking for ways to bring more value to you!