What is working capital, and why does it matter for cash flow?

Working capital is current assets minus current liabilities. It measures the money tied up in the day-to-day running of the business. In practice, bankers use operating working capital, which leaves out cash and debt, so it's mostly receivables plus inventory minus payables. It matters for cash flow because profit and cash aren't the same thing. An increase in net working capital uses cash, and a decrease frees it up. For example, if a company makes a sale on credit, it books the revenue but hasn't collected the cash yet. Receivables go up, and that increase is subtracted in cash flow from operations. Inventory works the same way, because buying more stock uses cash before anything is sold. Payables go the other way. Paying suppliers later keeps cash in the business for longer. That's why the change in net working capital is a line in free cash flow in a DCF or an LBO.

Working capital is current assets minus current liabilities. It measures the money tied up in the day-to-day running of the business. In practice, bankers use operating working capital, which leaves out cash and debt, so it's mostly receivables plus inventory minus payables. Cash and debt are left out because they're about financing, not operations. It matters for cash flow because profit and cash aren't the same thing. An increase in net working capital uses cash, and a decrease frees it up. For example, if a company makes a sale on credit, it books the revenue but hasn't collected the cash yet. Receivables go up, and that increase is subtracted in cash flow from operations. Inventory works the same way, because buying more stock uses cash before anything is sold. Payables go the other way. Paying suppliers later keeps cash in the business for longer. That's why the change in net working capital is a line in free cash flow in a DCF or an LBO. It's also why a fast-growing company can be profitable and still run short of cash. Growth usually means more receivables and inventory, and all of that has to be funded. Some businesses have negative working capital, like a supermarket that gets paid by shoppers before it pays its suppliers. For a business like that, growth actually brings cash in.