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 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 the negative rendition:
- 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, WC 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 WC cycles include: Online retailers, grocery stores, restaurants and telecom companies (via financialexpress.com).
That wraps up this week’s accounting breakdown.
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