Working Capital
Working capital is the difference between a company’s current assets (cash, receivables, inventory) and its current liabilities (payables, short-term debt, accrued expenses). It measures the resources available to fund operations over the coming year.
Changes in working capital are also the bridge between reported profit and actual operating cash flow.
The math
A company carries $240M of current assets against $150M of current liabilities, giving $90M of working capital. Now let revenue grow 25%.
Receivables and inventory tend to grow with sales, so current assets rise by roughly $50M while payables add only $20M of offsetting funding.
| Before growth | After +25% revenue | |
|---|---|---|
| Current assets | $240M | ~$290M |
| Current liabilities | $150M | ~$170M |
| Working capital | $90M | $120M |
Working capital expands by $30M, and that $30M is cash the company must find before a single new dollar of profit arrives.
For a business earning $40M a year, growth just consumed three quarters of annual earnings in cash terms.
The trap
Investors read growing working capital as strength when it is often the opposite. Receivables swelling faster than sales can mean customers are struggling to pay or the company is loosening credit terms to hit targets.
Inventory piling up means production has outrun demand and markdowns are coming. Both inflate current assets, both flatter the ratio, and both drain cash.
The write-offs arrive later, usually alongside a falling share price.
The move
Track working capital as a percentage of revenue across several years; a stable or falling ratio in a growing business signals operating discipline. Break the aggregate into its parts and watch days sales outstanding, inventory days, and payables days separately.
Negative working capital deserves attention too: some excellent businesses collect from customers before paying suppliers, effectively growing with other people’s money. Spotting which camp a company falls into is basic due diligence for anyone picking individual stocks.