Julian Shocron: Working Capital, and Why Growth Can Eat Cash
Julian Shocron looks at a concept that explains why plenty of businesses with strong sales still run short of money: working capital.
What is working capital?
It is the money a business needs tied up in day-to-day operations. In its operating form:
Working capital = receivables + inventory − payables
- Receivables: sales already made that customers have not paid for yet.
- Inventory: goods or raw materials bought but not yet sold.
- Payables: purchases already received that the business has not paid its suppliers for yet.
What happens at the bakery? (Fictional figures)
The bakery starts supplying a supermarket that pays 60 days after delivery.
| Item | Before | After |
|---|---|---|
| Receivables | 10 | 35 |
| Inventory | 15 | 15 |
| Payables | 10 | 10 |
| Working capital | 15 | 40 |
Sales went up, and working capital rose from 15 to 40. The 25 difference is sales not yet collected: the supermarket has the bread, but the money is still on its way rather than in the bank. That same 25 is subtracted when the bakery's free cash flow comes out at 35.
Why does it matter?
- It feeds into free cash flow: an increase in working capital is deducted when calculating it.
- It shows why growth costs money: more sales usually bring more receivables and more stock.
- It reflects bargaining power: collecting sooner or paying later frees up cash.
What is the cash conversion cycle?
Another way to see it is in days: how long it takes for money spent on stock to come back as a customer payment. The shorter the cycle, the less cash the business needs to keep running.
The short version
Working capital is the money tied up in customers and stock, minus what is owed to suppliers. When it grows, it absorbs cash even while the business is profitable. In the bakery's case, 25 of uncollected sales is the gap between profit and cash in the bank.
Educational note by Julian Shocron. Not investment advice.
More notes by Julian Shocron: julianshocron.com/en