According to the theory, if a client has negative working capital and a current ratio less than 1, "he cannot meet his current obligations." Therefore, if a credit operation of a client with these characteristics is presented, it should be denied.
But: what about service companies ? To mention one case: with passenger transport companies, where their Current Assets are markedly lower than their Current Liabilities? Should the premise also be applied?
For greater clarity, let's imagine that the Empresa de Transportes SA - whose sales are totally cash -, requested a loan of $.90,000 to acquire a new transport unit and recorded the following figures in its Balance Sheet:
Cash and Banks: $. 10,000
Supplies: $. 20,000
Total Current Assets: $. 30,000
Net Fixed Assets: $.300,000
Total Assets: $.330,000
Short Term Bank Debt: $. 70,000
Total Current Liabilities: $. 70,000
Long Term Bank Debt: $.140,000
Total Liabilities: $.210,000
Equity: $.120,000
Working Capital: ($.40,000)
Current ratio: 0.43
where the Bank Debt comes from loans to finance fixed assets.
Likewise, it will report the following information:
EBITDA: $.120,000
NET CASH FLOW (FCN): $. 50,000
Current part of the new loan: $. 30,000
Coverage: 166.67%
As can be deduced, the company would have the payment capacity to assume the new loan. But: would this be enough to ignore the negative working capital and the current ratio less than 1 that the company registers?
Before answering, we should first ask ourselves: Where is the company's EBITDA physically? Indeed, distributed among its various Assets! Both in Current Assets and Fixed Assets. A reading of the Cash Flow Statement of the business could clearly indicate that the main destination was the Investment Activities (purchase of fixed assets), which makes sense, since it would not make sense for the company to prefer to have cash surplus instead to invest in fixed assets, considering that transportation units are productive assets for the business. A simple decision of profitability vs. liquidity.
So: could the company cover its current obligations despite having negative working capital and a current ratio lower than 1? Would it be enough to have payment capacity, measured through the FCN? My answer is yes. Therefore, the relevant thing would be to analyze the Projected Operating Cash Flow of the business, where the payment of the current obligations incurred should be recorded.
A different situation would be if the company were commercial. In this case, the working capital must necessarily always be positive.
