By Eli Levi, Business Editor
Working capital is generally defined as current assets minus current liabilities. Following this equation, most companies should have positive working capital because they need enough current assets (cash & cash equivalents) to pay off their current liabilities. Stated simply, the company needs enough money to keep operating, i.e. to cover day-to-day costs, which is why working capital is occasionally dubbed operating working capital.
Based on the above-stated definition a company should dread ever having negative working capital as that shows that they do not have enough money to cover their current liabilities. Nevertheless, in some business models, especially those that are in the early high-growth stage, negative working capital can be a huge boon.
There is a liability called deferred revenue that drives this phenomenon. Deferred revenue is different from revenue because it has not been recognized as revenue yet. The way accounting works is that revenue is recognized when the service that the entity is paying for is performed. From an accounting standpoint, the cash received beforehand is recognized as revenue. Until the service is performed though that cash is recognized as a liability called deferred revenue.
Now that we understand what deferred revenue is we can jump into why negative working capital can be beneficial. A famous example of this is Amazon. Amazon has negative working capital because many of its services, including Prime, are paid for at the beginning of the year, yet Amazon performs the service throughout the whole year. This causes Amazon to have a very large deferred revenue balance because the money Amazon received at the beginning of the year for their prime service is going to be recognized as revenue throughout the year, not on the day they received the money.
For a growing company like Amazon, negative working capital can serve to fuel its business. When Amazon brings in all of its revenue at the beginning of the year it has the ability to reinvest all of that capital immediately into new projects. The earlier a company can reinvest the money it has the faster the business can grow. This is a major benefit to any company looking to grow quickly.