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Negative working capital is a situation in which a business is continuing to operate in spite of the fact that the liabilities held by the company are more than the company’s available assets. Essentially, this means that the accounts payable for the period of operation is more than the account receivables for the same period. While it is not unusual for a company to operate with negative working capital for a short period of time, most companies do not have the convertible assets to sustain the operation over the long term unless the situation reverses.
The easiest way to determine if a company is currently in a negative working capital state is to compare the accounts payable data for the most recently closed accounting period with the accounts receivable information for that same period. If the receivables are more than the payables for that period, the company is operating in a positive working capital situation. Should the payables exceed the amount of the receivables, then the working capital is considered negative.
Many companies do experience accounting periods when a negative working capital situation exists. Generally, these are short-term situations that take place because payments related to sales generated in previous periods have not yet been received and posted to the receivables. At the same time, the expenses found in the payables are posted and awaiting disposition. When customers take longer than thirty days to pay outstanding invoices, the supplier often experiences one month where negative working capital exists, then enjoys a positive working capital in the month that follows. When the entire operational year is considered, the company is usually found to be operating in the black, with the periods where income exceeded expenses offsetting the months where expenses were higher than the collected revenue.
For businesses where the negative working capital is not due to slower payment on outstanding invoices, steps to curtail expenses or otherwise reconfigure the business model may be necessary to bring the company back into a positive capital situation. For example, the business may seek to reduce expenses by revising departmental budgets, or attempting to secure lower pricing for materials used in the production of goods and services. If these efforts are not successful and the negative working capital situation persists for an extended period of time, the business is highly likely to cease operations. A possible exception is situations where the company has access to assets that can be converted into cash and used to retire some of the company’s outstanding debt, reducing the amount of the monthly payables to a level that is more in line with the monthly receivables.
Quite often, this is exactly the way nonprofits operate and there is nothing wrong with that. For example, a lot of trade association and chambers of commerce heavily depend on dues dollars collected at the first of the year. That money is received in a very short period of time and are budgeted to last the nonprofit for an entire year.
Yes, the payables are higher than the receivables throughout most of the year, but the budget is set up to accommodate that. That is not a common way for most businesses to operate but very typical of nonprofits.
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