What are changes in working capital?

Definition

These changes are how receivable, inventory, and payable swings use or free cash in the period. On the books, they are the Balance Sheet movements that explain why leftover profit is not the same as operating cash.

A wholesale bakery reads them when customers take longer to pay, when flour stock rises, or when vendor bills sit longer. Each swing either uses cash or frees cash.

They are period movements, not the standing cushion. The cushion is current assets minus current liabilities at a date; this page is how those accounts moved.

Current assets and current liabilities are the buckets. The cash story is the change inside accounts receivable, inventory, and accounts payable.

Where it shows up

Cash flow: Located in the operating section as the bridge from profit to cash.

Balance Sheet: Related to receivables, inventory, and payables moving.

P&L: Related to revenue and cost already recorded, which these movements can diverge from.

See also: Working Capital · Cash Flow From Operations · Cash Conversion Cycle

When you look at the Statement of Cash Flows, these swings sit in the operating section. They are the steps after leftover profit and after non-cash charges.

When receivables rise, cash is weaker than sales. When payables rise, cash is stronger than the costs already on the Income Statement.

The Balance Sheet is where you see the before and after. Subtract last month's receivable, inventory, and payable balances from this month's.

Revenue can be up while cash is down, if the extra sales are still in receivables. That gap is this cash effect.

A large use of cash here usually means the bakery is funding customers or stock. A large source usually means vendors are waiting, or stock was sold down.

These movements are not investing or financing. Buying a mixer or drawing a loan sits in other sections.

How it works

Compare this month's working-capital accounts to last month's. The difference is the cash effect.

If accounts receivable rose, the bakery delivered bread it has not collected. That increase uses cash relative to leftover profit.

If inventory rose, the bakery spent cash stocking flour and finished loaves. That increase also uses cash.

If accounts payable rose, the bakery held onto cash by taking longer to pay vendors. That increase is a source of cash.

The three swings net together. A receivable increase can wipe out a payable increase, and the net is what operating cash feels.

Stay with the cash effect when you read the lines. Do not treat the standing receivable balance as this period's use of cash; only the change counts.

Do not mix in a mixer purchase. That is an investing outflow, not a working-capital swing.

After the month closes, these changes are the period's timing story. Next month starts from the new balances.

Cost of goods sold is the flour that left with customers. Inventory can still rise if the bakery baked ahead, and that rise is a cash use here.

Example

Hearth & Barrel Wholesale posts a month where accounts receivable rose $10,000. That increase uses cash, because customers have not paid for bread already delivered.

Inventory fell $3,000, which is a source of cash. Accounts payable rose $4,000, which is also a source.

Net the three: $10,000 use minus $3,000 source minus $4,000 source. Working capital used $3,000 of cash.

The $3,000 is the cash drag from these swings. Leftover profit can still look healthy.

If the same month had no receivable increase, the other two sources would have freed $7,000. The leftover would not have to change for operating cash to improve.

A holiday bake that fills the freezer will raise inventory and use cash. Collecting last month's invoices will lower receivables and free cash.

Last quarter these swings used $8,000. This month's $3,000 use is smaller because payables and a stock draw-down helped.

Common mix-ups

Changes in working capital are not the same as working capital. Working capital is the standing cushion; this page is the cash effect of the movement.

Changes in working capital are not the same as leftover profit. Profit can be up while these swings use cash.

Changes in working capital are not the same as a days-to-cash measure. That cycle counts days between paying for inputs and collecting from customers; this page is the dollar cash effect in the operating section.

Related terms

• Working Capital: Current assets minus current liabilities, showing short-term operating cushion.
• Cash Flow From Operations: Cash generated or used by the day-to-day running of the business.
• Accounts Receivable: Money customers owe the business for goods or services already delivered.
• Inventory: Goods held for sale or used to produce goods for sale.
• Accounts Payable: Amounts the business owes vendors for goods or services already received.
• Indirect Method: Building operating cash flow by starting at net income and adjusting for non-cash and working-capital items.
• Cash Conversion Cycle: The number of days between paying for inputs and collecting from customers.
• Free Cash Flow: Operating cash flow left after the capital spending needed to keep running.