Working Capital

Working capital measures the short term resources a company uses to run its daily operations. It is the difference between current assets, such as cash, receivables and inventory, and current liabilities, such as payables and short term debt. Changes in working capital explain much of the gap between a company's profit and its cash flow. A business can be profitable and still run out of cash if customers pay slowly or inventory piles up, which is why traders watch working capital closely.

The basic formula#

working capital = current assets - current liabilities

Analysts often focus on operating working capital, excluding cash and debt:

operating working capital = receivables + inventory - payables

The main components#

The cash conversion cycle#

The cash conversion cycle (CCC) measures how many days cash is tied up between paying suppliers and collecting from customers.

DSO = receivables / revenue × 365
DIO = inventory / cost of goods sold × 365
DPO = payables / cost of goods sold × 365
cash conversion cycle = DSO + DIO - DPO

Negative working capital can be good#

Some businesses collect cash from customers before paying suppliers. Supermarkets, subscription software companies and some online retailers operate with negative working capital, meaning suppliers and customers effectively finance their growth. Amazon has long been cited as an example of a business with a negative cash conversion cycle.

Working capital and cash flow#

On the cash flow statement, increases in receivables and inventory reduce operating cash flow, and increases in payables add to it. See Cash Flow Statement.

Red flags#

Industry differences#

Supply chain finance#

Some companies use supply chain finance programmes, where banks pay suppliers early and the company pays the bank later. This can make payables look larger and operating cash flow stronger. Regulators introduced disclosure requirements for these programmes in 2023 after investors complained they were hidden.

Working capital in earnings analysis#

When reviewing quarterly results, compare the change in receivables and inventory with the change in revenue. If revenue grew 10% but receivables grew 30%, ask why. Management commentary on earnings calls often explains swings, such as a large customer paying late or inventory built ahead of a product launch. Persistent, unexplained divergence is a reason for caution. See Earnings Calls.

Frequently asked questions#

What is working capital?#

Current assets minus current liabilities, representing the short term resources a company uses in daily operations.

What is the cash conversion cycle?#

The number of days between paying suppliers and collecting cash from customers, calculated as DSO plus DIO minus DPO.

Is negative working capital bad?#

Not necessarily. Businesses that collect cash before paying suppliers, like supermarkets and subscription companies, often have negative working capital as a strength.

Next, learn about long term investment spending in Capex, Depreciation and Amortization.