Working Capital Question
Question 19 from M&I400 Accounting Section: What does negative Working Capital mean? Is that a bad sign?
The answer says "Retail and restaurant companies like Amazon, Wal-Mart, and McDonald's often have negative Working Capital because customers pay upfront - so they can use the cash generated to pay off their Accounts Payable rather than keeping a large cash balance on-hand. This can be a sign of business efficiency."
Some questions about this:
-Can someone explain why retail and restaurant companies have a negative WC in the first place (Walmart and Amazon makes some sense but McDonalds makes no sense to me at all)
-Secondly, how does using cash generated to pay off AP result in a negative WC? Wouldn't reducing AP result in lower 'current operational liabilities' which means WC becomes more positive.
Cash terms = no AR
Piggybacking off of this the cash is then used to pay down A/P which is an outflow of cash resulting in the aforementioned negative working capital.
Hey what’s up
On the second point, these suppliers are necessary for you to make the food upfront right? Meaning you can’t sell the cheeseburger if you don’t have the supplies readily available (not the case for all industries), so you supply the tomato, then instead of McDonald’s paying now, this payable is recorded, and basically settled after, when money is received from the customer. So instead of cash sitting somewhere, you can use the money you just received from your delicious triple cheese to pay the tomatoes, cheese, beef suppliers towards which you already have as payable.
Hope this clarifies.
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