Working Capital

Working Capital

Measure of liquidity available or short-term financial condition and efficiency of company. Working capital can show the operating liquidity of a company and how the company manages its business.



Working Capital


The Working Capital Ratio helps figure out whether a company has adequate short term assets to cover short term debt obligations.

A company can be rich with assets and very profitable but short of liquid assets that can be readily converted into cash. The current portion of debt (payable within 12 months)  is critical to monitor.

An increase in Working Capital indicates that current assets have increased or that current liabilities have decreased via paying off some short term creditor. The goal of managing working capital is to ensure that a firm can continue its operations and has sufficient cash flow for both maturing debt and any and all operational expenses.

What is the Working Capital Cycle?

The Working Capital Cycle is defined by the difference in which a company pays its suppliers and then collects its receivables

If a company pays in 30 days, but then takes 60 days to collect, then it has a 30 day cycle and it will commonly need to be funded via a bank operating line. An example of this is a retailer stacking up on inventory for the holiday season.

What is the Cash Conversion Cycle?

The Cash Conversion Cycle is the net number days from cash for material to receiving payment from customer. The lower this is, the less time cash is tied up in operations and unavailable for other uses.

While it has narrowed from it’s peak of over -40, Amazon has a negative cash conversion cycle of -9.46 reflecting the fact Amazon has managed to pay well after the customer first pays them. Much of this comes from the fact Amazon stores and fulfills 3rd party goods at a fee, and then collects money from customers well before it has to pay the supplier.

Simple Example

Say you own a retail store that sells groceries. After you’ve built the business and made Capital Expenditures like building the store, leasing the building, building out the store as you like then you still need to purchase the groceries you’re selling to customers.

The funds used to purchase the groceries for your store are considered working capital and how much working capital you need is defined by how quickly your suppliers make you pay for the groceries you’re selling. If a supplier made you pay for your inventory immediately then you would have to have that amount as working capital.

In reality suppliers will often extend credit to worthy businesses and you won’t have to pay for weeks or more. After purchasing inventory that inventory becomes an asset, but you have a liability equal to the amount owed to the supplier.  As long as you can continually sell groceries at a consistently quick pace and your supplier extends credit then you will never need to have full cash to purchase inventory.

On occasion you will encounter businesses with negative working capital. This happens when a customer pays for something before a company even has to pay suppliers.  If I sell apples at my store, and I am extended credit for the Apples for 30 days, but I sell out all the Apples in 3 days then I can use that capital to fund more inventory and continue the cycle before I even have to pay for those Apples. This offers an advantage to businesses because it allows a business to grow using the proceeds from working capital

Read about Change in Working Capital