Negative Working Capital

Working capital is receivables plus inventory less payables. It goes negative when a company collects from its customers before it pays its suppliers, so the operating cycle is funded by other people. A supermarket sells stock in three weeks and pays its suppliers in six. A software company bills twelve months of subscription up front and delivers the service over the year, holding the balance as deferred revenue. An airline takes the fare months before the flight.

The consequence is that growth releases cash instead of consuming it. Every new customer arrives with cash attached, so a growing business with negative working capital funds part of its own expansion from the float. In a DCF this shows up as a negative change in working capital adding to free cash flow, and in an LBO it is one reason sponsors will pay up for these models: the working capital swing is a source of funds rather than a use.

The same mechanism in reverse is the risk, and it is why it belongs in a credit conversation rather than only a valuation one. If volumes fall, the float unwinds: suppliers still have to be paid for goods already delivered while the new cash coming in has slowed. A business that looked comfortable on the way up can run out of cash on the way down without ever reporting a loss, which is the shape of a surprising number of retail failures.

Read it against the cash conversion cycle to see where it comes from: days inventory outstanding plus days sales outstanding less days payable outstanding. A negative cycle is the same fact expressed in days, and the days say which of the three levers is doing the work. Stretching payables to 90 days produces the same headline as collecting in three, and one of those is a durable model while the other is a supplier relationship that will eventually be repriced.