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Working capital is crucial for evaluating a company’s financial health over the past five years. If a company’s sales are growing, it typically needs to increase its working capital to support operations, which is generally positive. However, if sales growth stagnates or declines while working capital continues to rise, it signals internal issues within the company that need addressing.
A hallmark of a strong company is its ability to maintain positive changes in working capital. A positive change indicates that the company efficiently manages its capital, reducing the need for extensive resources to maintain competitive positioning and production volume. This efficiency boosts cash flow, which is beneficial for the company and its shareholders.
Investors should closely monitor the working capital percentage relative to sales. In quality companies with a competitive advantage (MOAT), incremental sales do not significantly increase working capital. Lower working capital relative to sales is preferable as it indicates efficient use of resources and stronger financial health.
Businesses with lower working capital requirements tend to generate higher cash flows. However, they may face heightened competition risks due to reduced financial buffers.
Negative working capital can benefit businesses during periods of sales growth but poses risks during economic downturns. If a company with negative working capital lacks sufficient cash reserves, it may encounter liquidity issues and potential bankruptcy threats.
When a company’s share price falls below 50% of its working capital, the market often predicts a scenario where the company may deplete its current assets, which can deter investors.
The most resilient companies thrive on float, leveraging others’ money, especially those with negative working capital and minimal long-term debt. Such companies demonstrate effective management practices, particularly when they achieve growth without significantly increasing working capital.
