Working Capital

How do you calculate net operating income after taxes if net operating income is negative?

The typical formula is net operating income after taxes = (1-tax rate)(NOI). What do you do if NOI < 0

Roll your negative Net Income into an operating loss carrywforward (assuming you’re modeling a C-corp).  This is called an NOL Carryforward (net operating loss carryforward).  There are certain rules and restrictions, but generally you can offset future taxable gains with your NOLs.  (These NOLs become pretty valuable once companies start generating real cash flow.)
Within Excel, this will require a few extra rows or nested If/Then statements. Just hide or group them in your spreadsheet and show Taxes = 0 until your NOLs are exhausted.  Most investors will know what you’re doing without any further explanation required.

If you are asking this question as an investor or to show numbers to investors, be careful about the answers you’re getting about NOLs. It’s rare to see a company acquired for the purpose of NOLs today (at least through a direct acquisition). This is because of 382 limitations on the usability of NOLs in the case of a change in control of a company’s equity rendering your NOLs almost worthless on a present value basis.
NOLs are currently limited to 3.98% of the value of the company during a change of control. This number is determined by the IRS monthly and (along with the value of the company for 382 purposes) will be fixed at the time of the change of control.

Based on your business and applicable tax laws, you may also have to distinguish between cash taxes and accounting taxes. The actual formula for NOI after taxes is simply: NOI – taxes. This is equivalent to (1-taxes) * NOI if your taxes are positive, but should be just NOI since your taxes are zero if your NOI is negative.

What is negative working capital?

 In accounting:

Working Capital = Current Assets – Current Liabilities

It is the amount of money that a business needs to stay in business. According to Business Insider:

Some businesses have negative working capital: they get money from sales before they pay suppliers.

For companies like Walmart and Amazon, they actually need no working capital because they negotiate deals in such a way that they only pay for things after 1-3 months. Most of the time, the stuff they buy is long sold by then. And people who go to Walmart to buy stuff will pay immediately, which means that Walmart is actually sitting on a pile of cash that it really does not need. So they can pay their debt slowly or use the extra cash for investment.
These businesses basically are financed by their customers. Negative working capital is a tremendous thing to have in a business

In business terms, working capital is defined as those funds a business needs to have available to met its day-to-day financial obligations. A sustainable business must have sufficient funds available at all times to meet its financial obligations as they fall due. This can be expressed in a layman’s formula:

Working Capital = Available funds – day to day financial obligations.

It’s not too hard to see that if working capital, according to this formula, was negative, then a business would not have sufficient fund to pay it financial obligations when they fell due. This situation makes the business technically insolvent which significantly increases the risk of the business being liquidated (i.e. forced to close).

So, this is one interpretation of the term negative working capital that should not be explored.

However, there is another interpretation of working capital where a negative result would not mean such a disastrous outcome. This is found in the accounting definition of the term working capital which can also be expressed as a formula:

Working Capital = Current Assets – Current Liabilities
The key elements of this formula are taken from the financial statements of the business and in particular, the balance sheet (also called the Statement of Financial Position). The key elements are:

  • Current assets are items of economic value that can be converted into cash within the current accounting period (usually 12 months). These items typically include cash, inventory, accounts receivable (what customers owe to the business).
  • Current liabilities are monies that a business owes to external parties (not owners) and are due for payment within the current accounting period (usually 12 months). These items are typically accounts payable (what the business owes to suppliers) plus other payables like income tax, council rates payable etc. …

As a rule finances like to see a positive working capital, according to this accounting formula, equivalent to the size of the current liabilities. i.e. meaning that the business has twice the amount of current assets as it has current liabilities. This outcome from the accounting working capital formula gives financiers confidence that your business will have more than sufficient working capital to meet its financial obligations as they fall due.

Now while this is the rule, there are some businesses that can remain sustainable while having a negative working capital according to the accounting formula. Lets take a look at the following example. (Note: These totals would be taken from the balance sheet):

  • Cash $10,000
  • Inventory $100,000 (let’s say, representing 4 months worth of sales)
  • Accounts Receivable $40,000
  • Accounts Payable $70,000
  • Taxes Payable $5,000

Applying our accounting working capital formula we get:

Working capital = (10,000 + 100,000 + 40,000) – (70,000 + 5,000)
= + positive $75,000

This is the result most financiers are looking for because the business has twice as much current assets as current liabilities. But let’s suppose that a similar business buys on credit from suppliers but sells for cash i.e. no accounts receivable. Let’s also suppose that this business still needs $10,000 cash on hand at all times to pay supplier accounts as they fall due but has found a way to operate on just one months supply of of inventory i.e. $100,000/4 = $25,000. Applying the accountingworking capital formula to this business we see:

Working capital = (10,000 + 25,000) – (70,000 + 5,000)
= – negative $40,000

This business still has the cash funds to pay its bills as they fall due yet the accounting working capital number is a negative amount. So, it is possible to have negative working capital according to the accounting formula and still have a sustainable and viable business, but there are a few keys in doing so:

  1. Buy inventory on long dated credit terms (30/60 days) from your suppliers but sell the inventory for cash to your customers (Cash on Delivery COD)
  2. Be very efficient with your inventory management. Carry the least amount of inventory possible and refill often. You could also sell only from a display item and have your supplier warehouse your back-up reserve stock.

In this regard negative working capital is a clever financing strategy because the business is actually using its suppliers working capital as its own. The best example of a business that is able to operate on a negative working capital basis, is MacDonald’s.