More of this Feature • Part 1: Lesson 3 Main • Part 2: How to Get Statements • Part 3: What's a Balance Sheet • Part 4: Typical Balance Sheet • Part 5: Current Assets • Part 6: Receivables • Part 7: Receivable Turns • Part 8: Inventory • Part 9: Inventory Turns • Part 10: Inventory Example • Part 11: Prepaid Expenses • Part 12: Current Liabilities • Part 13: Working Capital • Part 14: WC Per Dollar of Sales • Part 15: Negative Work. Cap • Part 16: Current Ratio • Part 17: Quick Ratio • Part 18: Long Term Investment • Part 19: Property, Plant, Equip. • Part 20: Intangible Assets • Part 21: Goodwill • Part 22: Deferred Charges • Part 23: Debt, Debt to Equity • Part 24: Other Liabilities • Part 25: Minority Interest • Part 26: Shareholder Equity • Part 27: Book Value • Part 28: Com. & Pref. Shares • Part 29: Cap. Surplus, Reserve • Part 30: Treasury Stock • Part 31: Retained Earnings • Part 32: Formula & Calculations • Part 33: Putting it all Together • Part 34: Segment 2

Related Resources • Investing Lesson 1 • Investing Lesson 2 • Investing Lesson 3 • More Investing Lessons

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Negative Working Capital

Some companies can generate cash so quickly they actually have a negative working capital.  This is generally true of companies in the restaurant business (McDonalds had a negative working capital of $698.5 million between 1999 and 2000).  Amazon.com is another example.  This happens because customers pay upfront and so rapidly, the business has no problems raising cash.  In these companies, products are delivered and sold to the customer before the company ever pays for them.

Don't understand how a company can have a negative working capital?  Think back to our Warner Brothers / Wal-Mart example.  When Wal-Mart ordered the 500,000 copies of a DVD, they were supposed to pay Warner Brothers within 30 days.  What if by the sixth or seventh day, Wal-Mart had already put the DVDs on the shelves of its stores across the country?  By the twentieth day, they may have sold all of the DVDs.  In the end, Wal-Mart received the DVDs, shipped them to its stores, and sold them to the customer (making a profit in the process), all before they had paid Warner Brothers!  If Wal-Mart can continue to do this with all of its suppliers, it doesn't really need to have enough cash on hand to pay all of its accounts payable.  As long as the transactions are timed right, they can pay each bill as it comes due, maximizing their efficiency.

The bottom line: A negative working capital is a sign of managerial efficiency in a business with low inventory and accounts receivable (which means they operate on an almost strictly cash basis).  In any other situation, it is a sign a company may be facing bankruptcy or serious financial trouble.

Buying a Company for Free

If you can buy a company for the value of its working capital, you essentially pay nothing for the business.  Going back to our Goodrich example; the company has $933 million in working capital.  There are currently 101.9 million shares outstanding, which means each share of Goodrich stock has $9.16 cents worth of working capital.  If GR's stock was trading for $9.16, you would basically be purchasing the stock for free (paying $1 for each $1 the company had in its checking account, inventory, etc.).  You would pay nothing for the company's fixed assets (such as real estate, computers, & buildings) and earnings.

For the past ten or twenty years, it has been incredibly rare for a company to trade that low.  You can still use the basic concept to your advantage; if you can find a business that is trading for working capital plus half the value of the fixed assets, you would be paying $0.50 for every $1.00 of assets. 

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