How Important is Working Capital in Financial Modeling?

How Important is Working Capital in Financial Modeling?

What is Working Capital?

Working Capital in Financial Modeling is a financial metric which represents operating liquidity available to a business. In the case of positive Change in Working Capital (WC), the change in current operating liabilities has increased more than the part of the current assets. And the reverse applies to the negative Change in WC.

The formula for Net Working Capital is: Working Capital (WC) = Current Assets – Current Liabilities

Components of Working Capital

Current Assets – tangible and intangible assets that the company can easily turn into cash within one year or one business cycle, whichever is less. For example, consider the checking and savings accounts, and highly liquid stocks. In addition, we can take the bonds and other marketable securities, accounts receivable, and more.

Current Liabilities include all the debts and expenses the firm expects to pay within a year or one business cycle, whichever is less. For example, rent, utilities, materials and supplies, interest or principal payments on debt, accounts payable, and other.

Working Capital vs. Net Working Capital

Working Capital in Financial Modeling represents a company’s overall liquidity and ability to meet short-term demands. However, we determine Net Working Capital by removing the cash from the asset category and short-term debt from the liability side of the equation.

The formula for Net Working Capital is: (Current Assets – Cash) – (Current Liabilities – Debt)

Working Capital vs. Cash Flow

Working Capital represents a company’s current financial situation. Cash flow, on the other hand, demonstrates how much cash a business can generate over a specified period of time (monthly, quarterly, or annually).

Working Capital vs. Fixed Capital/Assets

As mentioned previously, Working Capital is the measure of the liquidity required to operate the company on a daily basis.

Fixed capital (fixed assets) refers to an investment that benefits the company over the long term. For example, construction, the launch of a new product line, and so on.

Positive and Negative Working Capital

Positive working capital indicates if a company can quickly pay off its short-term liabilities. Negative working capital usually shows that a company is unable to do so.

Companies with positive Working Capital may face a problem. That’s the situation when they have only enough cash to pay for “day-to-day” operations. But they do not have enough cash for further expenses. If this occurs, it might mean that the company is:

  • having trouble moving its inventory
  • collecting receivables from customers too slowly
  • paying its vendor’s payables too quickly.

Assume that the company has little cash available and is unable to perform well in those three situations. In this case, it may run into problems paying bills and vendors.

Positive and Negative Factors for Working Capital

The most common factors that can positively and negatively impact a company’s Working Capital are listed below.

  • Credit Policy. If a company tightens its credit policy, outstanding accounts receivables will shrink. That’s because the customers are required to pay more quickly. Eventually, this will increase the amount of cash the company brings in. However, customers may buy less. Conversely, if a company grants customers more time to pay, cash will come in more slowly. But the customers may be encouraged to buy more goods on credit.
  • Inventory Planning. In anticipation of sales growth, a company may increase its inventory levels. In other words, increasing inventory will use cash, and shrinking inventory will free up cash.
  • Purchasing. In an effort to reduce unit costs, a company may reduce its costs and purchase materials in greater volumes. The initial outlay may be attributed more to larger volumes. However, more cash would be available over the long term due to cost savings.
  • Accounts Payable. A company may decide to change the way it pays vendors. Switching from 30-day net (where bills are paid monthly) to a 45-day net policy to free up cash.


  • Working Capital is the amount of available capital that a company can readily use for day-to-day operations.
  • This type of capital is a measure of a company’s liquidity, operational efficiency, and short-term financial health.
  • To calculate the Working Capital, compare a company’s current assets to its current liabilities, for instance by using the current ratio.

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