# Working Capital

> Working capital is current assets minus current liabilities. Learn how receivables, inventory and payables affect cash, the cash conversion cycle and warning signs.

Source: https://learn.tradelabsai.com/fundamentals/working-capital/  
Track: Fundamental Analysis · Level: Intermediate · Updated: 2026-10-03  
Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice.  
Cite as: TradeLabs Learn, "Working Capital", https://learn.tradelabsai.com/fundamentals/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

| Item | Effect on cash when it rises |
|---|---|
| Accounts receivable (money customers owe) | Uses cash: sales made but not yet collected |
| Inventory | Uses cash: goods bought or made but not yet sold |
| Accounts payable (money owed to suppliers) | Provides cash: bills not yet paid |
| Deferred revenue (cash received before delivery) | Provides cash |
| Accrued expenses | Provides cash |

## 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
```

**Example: Calculating the cycle**
A manufacturer has annual revenue of $730 million, cost of goods sold of $500 million, receivables of $100 million, inventory of $80 million and payables of $60 million.

- DSO = 100 / 730 × 365 = 50 days
- DIO = 80 / 500 × 365 ≈ 58 days
- DPO = 60 / 500 × 365 ≈ 44 days
- CCC ≈ 50 + 58 minus 44 = 64 days

Cash is tied up for about two months. If the company grows revenue 20%, working capital needs grow too, absorbing cash even as profits rise.

## 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](https://learn.tradelabsai.com/fundamentals/cash-flow-statement/).

## Red flags

| Signal | Possible problem |
|---|---|
| Receivables growing much faster than revenue | Aggressive revenue recognition or weak collections. See [Earnings Quality and Cash Conversion](https://learn.tradelabsai.com/fundamentals/earnings-quality/) |
| Inventory growing much faster than sales | Weak demand; risk of write downs |
| DPO rising sharply | Stretching suppliers, which may not be sustainable |
| Large one off working capital release | Boosts cash flow temporarily |
| Falling deferred revenue | Slowing future sales for subscription businesses |

## Industry differences

| Industry | Typical working capital pattern |
|---|---|
| Grocery retail | Low or negative; fast inventory turnover |
| Software subscriptions | Negative; customers prepay |
| Heavy manufacturing | High; long production cycles |
| Construction | High receivables; long contracts |
| Luxury goods | High inventory |

## 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](https://learn.tradelabsai.com/fundamentals/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](https://learn.tradelabsai.com/fundamentals/capex/).

## Continue learning

- Next lesson: [Capex, Depreciation and Amortization](https://learn.tradelabsai.com/fundamentals/capex/)
- Previous lesson: [Free Cash Flow](https://learn.tradelabsai.com/fundamentals/free-cash-flow/)
- Related: [Free Cash Flow](https://learn.tradelabsai.com/fundamentals/free-cash-flow/): Free cash flow is cash left after running and investing in the business. Learn how to calculate FCF, FCF yield and conversion, and why investors value it highly.
- Related: [Balance Sheet](https://learn.tradelabsai.com/fundamentals/balance-sheet/): The balance sheet shows what a company owns, owes and the equity left for shareholders. Learn the main items, key ratios and red flags traders look for.
- Related: [Cash Flow Statement](https://learn.tradelabsai.com/fundamentals/cash-flow-statement/): The cash flow statement shows where a company's cash came from and where it went. Learn the three sections, how to read them and why cash flow can reveal problems.
- Related: [Earnings Quality and Cash Conversion](https://learn.tradelabsai.com/fundamentals/earnings-quality/): Earnings quality asks whether reported profits are real, repeatable and backed by cash. Learn accruals, warning signs, the Beneish model and famous frauds.
- Related: [Unit Economics](https://learn.tradelabsai.com/fundamentals/unit-economics/): Unit economics measures profit per customer or unit sold. Learn lifetime value, acquisition cost, payback period, churn and how investors use these metrics.