Working Capital Series: Cash-Positive and Cash-Negative Profiles

The working capital profile of a business can either deliver an ongoing surplus of cash (above earnings) or can cause an ongoing drain of cash (below earnings).

This first diagram shows a situation in which there’s a cash drain on the business in question. If the business is selling its goods for more than it paid for them, then the cash drain is less than the cash expected to be received, but it’s the timing that we’re most concerned with. If the costs must be paid now but revenues are received in 11 months, an accountant may call this profitable, but the business may not be viable in a realistic sense.

Especially in a high growth business, it can be difficult to sustain a cash drain, even for a few days (think millions of dollars for a business that is too early stage for traditional sources of funding).

The second diagram shows a business with a working capital cash surplus. This occurs because it receives cash from its customers before it has to pay its suppliers. This is a nice position to be in, but is difficult to achieve. If a business has a unique position (usually if it accounts for a large portion of supplier sales) it can enforce longer creditor days. Sometimes just the nature of a particular market (such as insurance) will support this type of working capital profile.

A cash-negative working capital position (the first diagram) means that money is tied up, which incurs an interest charge if it’s borrowed or an opportunity cost otherwise.

A cash-positive working capital position (the second diagram) means that surplus cash is available, for a short period, which may produce interest income or allow for other profitable investment.

There are businesses operating right now that have such large negative working capital positions that the ongoing shortfall is greater than the earnings multiple valuation of the business. In these cases, you really must question whether the business is viable in the long term. On the flipside, businesses that have large positive working capital positions can continue to create income from non-operational activities (such as investment), which is the premise behind the float of insurance companies and arguably a big factor in Buffett’s wealth today.


Working Capital Series:

  1. Introduction
  2. References and Calculations
  3. Drivers
  4. Cash-positive & Cash-negative Profiles
  5. Valuation
  6. What To Do At Settlement
  7. The Locked Box Approach
  8. Measuring & Monitoring
  9. Improvements & One-off Cash Wins
  10. Preparing For Sale


Due Diligence, Working Capital

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