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Some Thoughts About Working Capital

Working capital relates to all current assets and liabilities that a company uses to run its operations.

Note that there are different definitions and approaches. A generic approach is to calculate current assets minus current liabilities. Yet, this does not account for potential debt-like items, which could be included in current assets or liabilities. Another approach is to review all balance sheet accounts and determine working capital “manually”.

Working capital can be divided into two relevant groups: trade and other working capital. Trade working capital mainly contains inventories, trade receivables, and trade payables. Other working capital comprises all relevant receivables, payables, and provisions. These are required to run the company and its operations.

In the following article, I am going to introduce the general aspects of working capital.

Main purposes

  • Define a company’s working capital and understand movements herein.
  • Determine the reference working capital, which will be used in the purchase price agreement. If the working capital at closing of the deal exceeds the reference working capital, the buyer needs to compensate the seller for this. Vice versa if the actual working capital is below the reference working capital.


  • Understand the business model of the company and which implications it has on working capital. For example, in the acquisition of an automotive supplier, most people would classify cash into net financial cash and debt. However, when running a due diligence on a supermarket, cash will be core — without it, the supermarket wouldn’t be able to operate its business.
  • Understand developments: this needs to be done jointly with the income statement. If there is a revenue seasonality, it is easier to understand fluctuations in trade receivables. Oh, and inventories or trade payables should show fluctuations some time before revenue is generated, as the product needs to be manufactured before.
  • Understand what the adequate level is. Here, it’s about the reference working capital and this can be challenging when it comes to high-growth or shrinking businesses. Let’s stick with growth. Is the growth volume-based or price-based. Does growth have an impact on inventories? Should inventories be determined in absolute or monetary terms?
  • Understand the working capital seasonality. Working capital often fluctuates. For example, a bike shop typically purchases in early spring (so-called inventory build-up) while sales occur in late spring or early summer. In autumn, the bike shop sells the remaining bikes at a discount to make space for the new models of the upcoming bike season. These intra-year fluctuations often demand intra-year financing. This is something a potential acquirer needs to look at, e.g. by calculating monthly cash flows and monthly working capital.

Key takeaways

  1. Understand the business model to draw meaningful conclusions about a company’s working capital
  2. Understand the development and movements
  3. Define how the reference working capital looks like
  4. Understand any requirements for intra-year financing

Final thoughts

This article provides a general overview of working capital and its main challenges. There are many challenges related to working capital, such as how to derive the reference working capital, or how to understand the individual components of working capital. Future articles will deal with the individual components in more detail.

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