A company has negative working capital because it collects cash from customers upfront but pays suppliers later. How does this affect your DCF valuation, and what trap must you avoid when projecting free cash flows?
An advanced Valuation question — expect it in final rounds and case-heavy interviews (IB, PE, Big-4 Transaction Services).
THE SHORT ANSWER
Negative working capital acts as a source of funding, boosting free cash flow in early years as the company grows. However, a common trap is to assume this benefit persists indefinitely. In a steady state, working capital as a percentage of sales stabilizes, so the cash inflow from negative working capital growth stops. If you project perpetual negative working capital growth, you overstate terminal value. I would normalize working capital in the terminal period to reflect no net investment.
WHAT INTERVIEWERS LISTEN FOR
- ✓Negative working capital boosts FCF during growth phase
- ✓Trap: projecting perpetual negative working capital growth
- ✓Normalize to zero net investment in terminal value
COMMON MISTAKES
- ✗Claiming negative working capital always increases value
- ✗Ignoring that growth eventually stabilizes
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