Working Capital
The capital tied up in a business’s short-term operating cycle: receivables plus inventory, minus payables. Changes in working capital are a key adjustment between EBITDA and free cash flow.
Why Working Capital matters in interviews
Working capital is where accounting meets cash, and interviewers use it to check that you know profit and cash are different things. It also runs straight into deal mechanics — the working capital adjustment is one of the most negotiated items in any purchase agreement.
How it works in practice
Operating net working capital = accounts receivable + inventory − accounts payable. The financing items (cash and short-term debt) are excluded, because working capital is meant to measure the operating cycle.
An increase in working capital consumes cash: you have shipped goods and not been paid, or bought stock you have not sold. That is why the change in working capital is subtracted in a free cash flow build.
A growing business with 60-day receivables and 30-day payables funds its own customers. This is why fast-growing but profitable companies still run out of money — and why negative working capital models (subscriptions, supermarkets) are so prized: customers fund the business.
What candidates get wrong
- Including cash and debt in the working capital calculation. Deal practitioners use *operating* working capital for exactly this reason.
- Getting the cash-flow sign backwards. Increase in working capital = cash outflow.
- Not knowing what a working capital peg is — the normalised level of working capital a buyer expects to be delivered at closing, with the price adjusted up or down against it.
Working Capital: frequently asked questions
Why does an increase in working capital reduce cash flow?
Because it represents cash tied up in the operating cycle. A rise in receivables means revenue was recognised but not collected; a rise in inventory means cash was spent on stock not yet sold. Both reduce cash even though neither reduces profit.
Can working capital be negative, and is that bad?
It can be, and it is often excellent. Businesses that collect from customers before paying suppliers — supermarkets, subscription software, airlines selling tickets in advance — run structurally negative working capital, meaning growth generates cash rather than consuming it.
Go deeper
This term comes up constantly in corporate finance interviews and on the desk.
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