Negative working capital is not always

negative
We explore how some businesses are better than others in dealing with negative working
capital

28-Dec-2022 •Udhayaprakash

Working capital means the amount of money a business needs to meet its near-term
obligations, i.e., money for running its business, short-term debt, etc. It is defined as
the difference between a company's current assets and current liabilities.

Working capital = Current assets - Current liabilities

So if a company has high near-term liabilities, it will have less capital available to run
its business.

Sounds simple enough. So why should any investor put their money on a company
with negative working capital?
Because in investing, dealing in absolutes is never a wise call. While it is true that
negative working capital should invite more vigilance from investors, some
businesses actually fare better when their working capital is in the red.

Take the example of consumer-facing companies like Devyani International, which

operates Pizza Hut in India. It purchases raw materials from its suppliers on credit.
However, as soon as the pizza hits the plate, the customer pays. This means the
company converts its inventory and receivables to cash before it has to pay its
suppliers (a negative cash conversion cycle).

So, while the working capital might be negative on paper, the company will not be
strapped for cash.

This is also true for companies in the B2B space. For example, Sundaram-Clayton,
which makes aluminium casting dyes for OEMs (original equipment manufacturers),
had negative working capital in three out of the last five years. However, it managed
to live through the five years because of its negative cash conversion cycle in each
of the five years.

Thus, if a company has little to no debtors and a negative or short cash conversion
cycle, that negative working capital figure might not be all gloom and doom.

The table below lists some companies with negative working capital and have lived
through those years of negative working capital without much sweat.

But beware of short-term borrowings

It is important to mention that a company can live through periods of negative
working capital only if its short-term borrowings are low and it has a short cash
conversion cycle.
For example, Tata Power and Adani Power sure had to put in a shift to deal with five
years of negative working capital as they had relatively long cash conversion cycles
of 148 days and 74 days, respectively.

To sum up
So, if you are up against a balance sheet with negative working capital, make sure
the company ticks the following checkboxes:

 Receives payment from customers before it has to pay the suppliers.

 Short or negative cash conversion cycle.
 High trade payables but low short-term borrowings.


The big 'ROCE' daddies
Before we give the list of companies that have earned a high ROCE, we explain what ROCE
is and how we arrived at this list

06-Oct-2022 •Udhayaprakash

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What is ROCE?
Return on capital employed or ROCE is a basic yet important measure. As the name suggests,
the formula computes the return that a company has achieved on the capital it employed
during the year. A bit confusing? Well, let's look at the formula:

Now
assume
that a
company
is a
person and it has some money (which is its capital). So, if a company chooses to invest its
capital, it should invest in an avenue where it can get superior returns, right? At least 11 - 12
per cent which is the average returns of Sensex and Nifty in the long run. That is what ROCE
is. It shows whether a company has deployed its capital wisely and has earned superior
returns on the investment.

An analysis
Now we were curious about which companies have been really good. So we did an analysis -
companies that have earned more than 25 per cent ROCE every single year for the last 10
years. We also added three more filters:

 Current market capitalisation of more than Rs 1,000 crore,

 10-year revenue growth of more than 10 per cent, and
 10-year profit growth of more than 10 per cent.

After applying all these filters, we arrived at 15 companies and the returns that they generated
during the period. As you can see in the table, some return cells may be empty as those
companies weren't listed 10 years ago.

Let's say
you
invested
Rs 1,000
in all of
these
companies 10 years ago, which means a total investment of Rs 9,000 (only in the listed ones).
At the end of 10 years, you will have Rs 1,53,439, i.e., 32.8 per cent annual returns!

Yes, we got 10 year data even for companies that weren't listed. How? Because we
have Value Research Stock Advisor. By subscribing, you will get not only stock
recommendations but also ten-year financials for all the companies (given that they existed
for 10 years).

Suggested read:
Returns up, but P/E...down?
Free cash flow kings

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