Working Capital | Investing Glossary

What it is

Working capital is the capital a business needs to fund its operations between the point it pays for inputs and the point it receives payment from customers. The formula is straightforward:

**Working Capital = Current Assets − Current Liabilities**

But the actionable version — the one analysts focus on — is the operational working capital:

**Net Working Capital = Inventory + Trade Receivables − Trade Payables**

This excludes cash, short-term investments, and financial debt (which are balance sheet and capital structure items), focusing purely on the operational funding cycle.

Why it matters for cash flow

This is the reason a company can report growing profits while its cash position deteriorates: if working capital is expanding — customers taking longer to pay, inventory building, suppliers being paid faster — cash is being consumed even when the P&L looks healthy.

The working capital cycle works like this: a manufacturer buys raw materials (pays cash), turns them into finished goods (inventory), sells them (creates a receivable), and eventually collects payment (cash in). The longer each stage of this cycle takes, the more cash is tied up in the process.

A business with £1bn of revenue and 60 days of outstanding receivables has approximately £164m of cash tied up just waiting to be collected. Reduce that to 45 days and you release £41m — without growing revenue by a penny.

The cash conversion cycle

The cash conversion cycle (CCC) formalises this:

**CCC = Days Sales Outstanding + Days Inventory Outstanding − Days Payable Outstanding**

DSO (Days Sales Outstanding): Average days taken to collect receivables
DIO (Days Inventory Outstanding): Average days inventory is held before sale
DPO (Days Payable Outstanding): Average days taken to pay suppliers

A negative CCC — where you collect from customers before you pay suppliers — is the hallmark of a remarkably powerful business model. Amazon, Tesco, and Ryanair all achieved this in their growth phases: customers pay at point of sale, suppliers get paid 30–60 days later. The business essentially operates on other people's money.

Working capital as a quality signal

Deteriorating working capital — DSO rising, DIO rising, DPO falling — suggests the business is losing negotiating power with customers and suppliers, or that credit quality is deteriorating. If receivables are growing much faster than revenue, ask why. Customers might be struggling to pay. Sales might be booked prematurely. Channel stuffing — pushing inventory into distributors at period end to hit revenue targets — will show up here.

Structurally negative working capital — retail, subscription businesses, online platforms — is a competitive advantage. These businesses receive customer cash before incurring costs, providing a built-in source of funding that reduces the need for external borrowing.

Working capital-intensive businesses — manufacturing, construction, professional services with long project cycles — require external funding to bridge operational cycles and are inherently more financially complex to manage.

**Analyst's check:** Take the last five years of working capital as a percentage of revenue. If it's been stable, the business is managing its cycle consistently. If it's been rising — working capital consuming an increasing share of revenue — that cash is coming from somewhere: debt, equity, or reduced dividends. Understand why before drawing conclusions.

Not financial advice. Working capital analysis is most valuable when read alongside the cash flow statement.