Also: net working capital, current assets, current liabilities, cash conversion cycle, operating cycle
The difference between current assets and current liabilities: the short-term resources, such as cash, receivables and inventory, that remain once obligations falling due within the operating cycle or the next twelve months are set against them.
Our take. More working capital is not automatically better. A large positive figure can mean unsold stock and customers who are slow to pay, both of which lock up cash, while a negative one can signal strength in a business whose customers pay before its suppliers must be paid. Watch the direction of change and how quickly each component turns back into cash, not the size of the total.
Where the current line falls
Working capital inherits its boundaries from the balance sheet. Under IAS 1 an asset counts as current when it will be realised, sold or consumed within the entity's normal operating cycle or within twelve months of the reporting date, so inventory and trade receivables are current even where the cycle runs longer than a year. A liability is non-current only when settlement is not due within twelve months, and amendments effective for periods from 1 January 2024 clarified how that test is applied. Underneath sits the operating cycle, the time from buying inputs to collecting cash from customers: a distiller ageing spirit and a café selling coffee have very different cycles and therefore very different funding needs.
Component
What it measures
Effect of shortening it
Receivables
How long customers take to pay
Cash arrives sooner
Inventory
How long stock waits before it is sold
Less cash sits on the shelf
Payables
How long the business takes to settle with suppliers
Cash leaves sooner, so paying later funds the other two, until suppliers object
Cash conversion cycle
Days of receivables plus days of inventory minus days of payables
Cash is tied up for fewer days in total
Changes in these balances are the bridge between profit and cash flow. An increase in working capital absorbs cash that the income statement never shows, which is how a fast-growing company can be profitable and short of money in the same quarter. In valuation, the investment in working capital is deducted when free cash flow is estimated for a discounted cash flow model, and lenders look at it beside EBITDA because EBITDA leaves it out entirely. Reading the balances off the financial statements and forecasting them in days rather than in currency is standard practice in financial analysis and modelling. Days are easier to challenge than totals: a forecast that assumes customers will suddenly pay a fortnight faster should come with a reason, such as new payment terms or a change in the customer mix.
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