BALANCECHEAT / FIELD NOTES

Working capital and its effect on cash flow

A sale is not always a receipt. Working capital explains how day-to-day operations tie up cash between buying, selling and getting paid.

Working capital: the broad definition

Working capital = current assets − current liabilities

Current assets include cash, receivables, inventory and other short-term assets. Current liabilities include payables and other near-term obligations, including current debt where applicable. “Net working capital” often means the same thing; terminology varies across analysis and transaction work.

Operating net working capital

For modeling operations, it is useful to exclude cash and financing. BalanceCheat explicitly labels this narrower measure as operating net working capital, or operating NWC.

Operating NWC = receivables + inventory + other operating current assets − payables − other operating current liabilities

Baseline debt is long-term. Any cash deficit is funded by an explicitly modeled hypothetical current revolver, included in current liabilities and liquidity ratios. This is required funding, not a credit commitment. In a real business, identify the current portion of debt before calculating broad working capital or liquidity ratios. An acquisition agreement can define working capital differently again.

Why an increase consumes cash

If revenue is recognized before the customer pays, the receivable grows without a cash receipt. If goods are purchased and stored, inventory grows before their sale. If payment to suppliers is deferred, payables preserve cash. Therefore an increase in operating NWC is generally subtracted in the indirect cash flow reconciliation.

A worked example

Receivables rise from €400k to €500k, inventory from €300k to €350k, and payables from €250k to €280k. Operating NWC rises from €450k to €570k. The €120k increase reduces CFO by €120k, all else equal. This is a timing effect, not an extra expense.

Common mistakes and interpretation

Do not subtract closing NWC from cash flow: subtract its change. Do not include cash itself in the operating NWC adjustment, or the reconciliation becomes circular. Higher broad working capital may improve a liquidity buffer, while higher operating NWC may signal slower collections or excess stock. Context matters.

Explore DSO, DIO and DPO to understand the drivers. Then follow the effect on free cash flow and ROIC.