Change in Working Capital


We discussed Working Capital here.

Change in Working Capital

Even though Accounts Receivables are listed as an assets they are in many ways a liability because they are in essence an interest free loan to the customer until they are paid.

When the company is paid the Accounts Receivables are decreased, and the cash flow increases, which would be a change in working capital.

It is a red flag if too much of a companies sales are Accounts Receivables and they are not decreasing at a quick enough rate.

An additional component of working capital is inventory which can also be considered a liability while in the same way that Accounts Receivables is liability, Accounts Payable is an interest free loan to the company and money you owe but haven’t had to pay yet.

Rising Accounts Payable is also important to look at too since this is cash that hasn’t left the balance sheet but will in the future.

The reason inventory is considered a liability is that the time you hold that inventory is time that capital can not be redeployed so it technically has a hold cost, and part of the hold cost is the risk you can not sell it before it spoils, or depreciates.

Changes in Accounts Receivable, Payable and Inventory 

The way a company manages it’s accounts receivable, payable and inventory dictates how much working capital a company needs to operate. If it is efficient in the cycle, then it needs less. In an extreme case a company like Amazon has a negative cash conversion cycle and actually is paid before it has to be paid. This has narrowed from -40, to -9 recently but it is still impressive.