In this blog, we focus on two causes of negative working capital and how to overcome them.
When it comes to financial management, working capital takes precedence as one of the most important aspects of a business. However, within its framework lies a less-discussed but equally crucial concept: negative working capital.
Negative working capital occurs when a company’s short-term liabilities exceed its short-term assets. While it may not necessarily indicate financial distress, it highlights the importance of effective working capital management in maintaining liquidity and supporting business operations. Both are actually closely related.
2 Causes of Negative Working Capital
1. Delayed receivables
The most common reason for negative working capital is delayed receivables. This is when a company’s accounts receivable (the money owed to them by customers) takes longer to collect than its accounts payable (the money owed by the company to suppliers and creditors). This imbalance can occur due to various factors, including lenient credit terms offered to customers, slow payment processing procedures, or changes in customer payment behaviour.
When receivables are delayed, the company experiences a cash flow gap, resulting in negative working capital. While delayed receivables may be indicative of strong sales or growth, they can also strain the company’s liquidity and financial stability if not managed effectively.
To overcome delayed receivables, businesses can review and adjust credit policies to shorten payment terms for customers. They can also incentivise customers to pay invoices promptly by offering discounts for early settlement.
2. Rapid growth
Another reason for negative working capital is rapid growth or expansion initiatives undertaken by a company. In cases where a business experiences significant growth in sales or expands its operations, it may need to invest heavily in inventory, equipment, and other resources to support increased demand.
This upfront investment often leads to an imbalance between current assets (inventory and accounts receivable) and current liabilities (accounts payable and short-term debt). All of which result in negative working capital. While rapid growth is generally viewed as a positive sign for a company, it can strain working capital resources. It requires careful management to ensure financial stability and sustainability.
Managing rapid growth can look like negotiating flexible payment terms with suppliers. Businesses can also implement inventory optimisation strategies to minimise carrying costs and improve turnover. Another way is to develop reliable cash flow forecasts to anticipate the projected cash requirements needed to continue growing the business without compromising on resources.
By addressing these causes of negative working capital proactively, businesses can keep their financial health and stability in check. It is through the collaboration of all stakeholders who carefully plan out the associated strategies while monitoring their progress continuously that success can be maintained. Therefore, it is crucial for businesses to work as one team.
Learn more about B2BE’s Supply Chain Finance solutions.
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