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Learn/DCF Valuation/Module 5
5.3·7 min read

Net Working Capital

NWC is the cash tied up in day-to-day operations. Increases consume cash; decreases free it. This is the most-missed line in UFCF.

By the end you can
  • ✓Compute net working capital from the balance sheet
  • ✓Explain why an increase in NWC reduces free cash flow
  • ✓Translate a change in NWC into a cash impact
Net working capital

Non-cash current assets minus non-interest-bearing current liabilities. It's the cash a business must keep tied up to operate - money owed by customers (A/R) and sitting in inventory, net of what it owes suppliers (A/P).

NWC=(A/R+Inventory+Prepaids)−(A/P+Accrued+Other CL)\text{NWC} = (\text{A/R} + \text{Inventory} + \text{Prepaids}) - (\text{A/P} + \text{Accrued} + \text{Other CL})
Exclude cash (it's not operating) and debt (it's financing, not working capital).
The intuition that makes it click

An increase in A/R is a use of cash - you booked the sale but haven't collected. An increase in A/P is a source of cash - you got the goods but haven't paid. So building up receivables and inventory ties up cash; stretching payables frees it.

Worked example · Compute NWC
Given
  • •Current assets - A/R $250, Inventory $200, Prepaids $50 (Cash $100 excluded)
  • •Current liabilities - A/P $175, Accrued $100, Other $5 (current debt excluded)
Solution
  1. 1.Non-cash current assets
    250+200+50=500250 + 200 + 50 = 500
  2. 2.Non-debt current liabilities
    175+100+5=280175 + 100 + 5 = 280
  3. 3.Net
    500−280=220500 - 280 = 220
Answer

= $220. Cash and the current portion of debt are deliberately left out - one is non-operating, the other is financing.

It's the CHANGE that hits cash flow

uses ΔNWC, the year-over-year change, not the level. ΔNWC=NWCthis year−NWClast year\Delta\text{NWC} = \text{NWC}_{\text{this year}} - \text{NWC}_{\text{last year}}. An increase is subtracted (use of cash); a decrease is added back (source of cash). Growing companies usually have rising - a normal, ongoing drag on cash.

Check yourself

A company's NWC rises from $200mm to $230mm over the year. The effect on this year's UFCF is:

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Building UFCF, Line by Line
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Projecting Working Capital