What is working capital and why does a Financial Analyst care about it?

What the interviewer wants to hear

• Current assets minus current liabilities, or operating version: receivables plus inventory minus payables
• Shows short-term liquidity
• Growth often needs more working capital and consumes cash
• Measured with DSO, DIO, DPO and the cash conversion cycle

Model answer

Working capital is current assets minus current liabilities. For analysis I usually focus on operating working capital: trade receivables plus inventory minus trade payables. It matters because it is cash tied up in running the business. A company can be profitable and still run out of cash if customers pay slowly or stock piles up. When a business grows, receivables and inventory usually grow too, so growth consumes cash even before any capex. I track it with DSO, DIO and DPO and combine them into the cash conversion cycle. For example, if a distributor collects in 60 days but pays suppliers in 30, it needs to fund 30 days of sales, often through a bank working capital limit. Reducing DSO by ten days can release a lot of cash without any new borrowing.

More easy Financial Analyst questions

• Walk me through how the three financial statements are linked.
• Your sales head asks why marketing costs were 20% over budget last month. How do you investigate and explain it?
• Which profitability ratios would you look at for a manufacturing company, and what does each tell you?
• How would you build an annual budget for a business unit?
• Why is the cash flow statement important if we already have the income statement?
• How do you check an Excel financial model for errors before you send it to your manager?
• What is EBITDA, why is it popular, and what are its limitations?
• Explain fixed and variable costs with an example and why the split matters for decisions.
• How do you present financial results to managers who do not have a finance background?