TechniqueFrameworkAccountingGrowth and business models
Working capital is where growth eats cash, even when the income statement looks healthy
The Finance Storyteller · Working Capital Explained
The idea
Receivables are sales not yet paid for; inventory is cash sitting on a shelf; payables are purchases not yet paid. Grow the business and the first two grow with it, which means cash goes out before it comes back. The Finance Storyteller defines working capital and then reads it off two real companies, which is the useful part: the same accounting line means something different for a manufacturer with months of inventory and a software company whose customers pay in advance. Knowing which kind of business you are looking at tells you whether growth will consume cash or produce it.
Growth ties up cash in receivables and inventory, so model the working capital a business needs before trusting its profit.
When it works
Three-statement questions, cash flow forecasting, and any growth company whose profit and cash are diverging.
When it may fail
Working capital can be managed, stretched and flattered at a period end, so a single balance sheet date can mislead. Use several and watch the trend.
How to use it
For a company, compute days of receivables, inventory and payables, and the cash the next year's growth will absorb at those levels. Shoe Dog is the same calculation told as a near-death experience.
Where it came from
Video Working Capital Explained · The Finance Storyteller
What the source says. The Finance Storyteller defines working capital and then reads it off the balance sheets of 3M and Microsoft, showing how differently the same line behaves in two businesses.
Connected ideas
Says something similar
Growth consumes cash, and a profitable company can still run outProfit is not cash, and growth widens the gap; model the cash a business needs to grow before admiring its sales.
Worth knowing first
Net income and cash flow diverge by design: revenue is recorded when earned, not when paidAccrual profit is the economics of a period; cash is the bank account. Every difference is a timing gap that the cash flow statement reconciles.
Concepts
Put it to work on L3VLUP
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