How do changes in working capital affect a company s cash flow?
Working capital represents the difference between a firm’s current assets and current liabilities. For well-run firms, managing working capital is simply a daily occurrence that can be handled easily. For other firms, the way the process is handled can indicate financial distress.
The impact of working capital changes are reflected in a firm’s cash flow statement. Specifically, the operating cash flow (OCF) section of the cash flow statement details changes in its shorter-term working capital needs. A positive working capital figure (current assets are greater than current liabilities) means a cash inflow for the period measured. In contrast, a negative working capital position means the firm has spent more cash out than it brought in managing its working capital, or commitments, within a year. Analyzing changes in working capital can be important for any business, but is especially important for firms with seasonal or erratic cash flow needs.
For instance, retailing giant Wal-Mart Stores Inc (WMT ), like most retailers, spends a considerable amount of working capital prior to the holiday season.
Looking at Wal-Mart’s 2016 cash flow statement for the fiscal third quarter ended October 31, 2016, we can see that it spent $6.57 billion (reflected as a cash outflow) on inventory. This contrasts sharply with the other three quarters. In its first and second quarters, spending on inventory was minimal and came in at $264 million and $791 million (both cash inflows), respectively. In the fourth quarter, inventory decreased by a wide margin and the change in working capital was favorable as it went up from -$10.73 billion to -$9.24 billion.
As another example, let’s look at Blockbuster, the video rental chain that went bankrupt, had a working capital situation that was much grimmer. In fiscal 2010, its change in accounts payable and accrued expenses totaled a cash outflow of nearly $250 million and it came following a reported loss of close to $600 million. At the time, cash on hand was only $190 million. With a negative working capital, the company was not able to meet its short-term obligations. Later that year, the firm filed for bankruptcy.
Most of the time, a company’s working capital is simply a core part of its daily operations. But it can indicate financial problems, especially when working capital runs in the negative for an extended period of time.
Learn under what circumstances negative working capital can arise and what it means when working capital stays negative for. Read Answer >>
Find out what working capital is used for, including how to calculate this financial metric by subtracting current liabilities. Read Answer >>
Find out the significance of working capital management for a company and look at the working capital ratio analysts use. Read Answer >>
Learn about a company’s working capital; good working capital management is essential to maintaining a company’s liquidity. Read Answer >>
Learn about the cash flow statement and cash flows from operating activities, and observe some examples of cash flows from. Read Answer >>
Understand how working capital may affect a company’s financial strength and investment effectiveness, as it changes from. Read Answer >>