The excess of current assets over current liabilities is referred to as the company’s working capital. The difference between the working capital for two given reporting periods is called the change in working capital.
Changes in working capital is included in cash flow from operations because companies typically increase and decrease their current assets and current liabilities to fund their ongoing operations. When a company increases its current assets, it’s a cash outflow: The company had to shell out money to buy the extra assets. Likewise, when a company increases its current liabilities, it’s a cash inflow: The added liabilities, such as short-term debt, provide money. Changes in working capital simply shows the net affect on cash flows of this adding and subtracting from current assets and current liabilities. When changes in working capital is negative, the company is investing heavily in its current assets, or else drastically reducing its current liabilities. When changes in working capital is positive, the company is either selling off current assets or else raising its current liabilities.
This information is found in the Statement of Cash Flow of the company’s financial statement.
For the Pros
For many growing companies, changes in working capital is a little like capital spending: It’s money the company is investing—in things like inventory—in order to grow. To get a true picture of the cash a company is generating before investment, one can add back changes in working capital to cash flow from operations. Another point: A negative value for changes in working capital could mean the company is investing heavily in growth, or that something’s gone wrong. If a company is having trouble selling its goods, inventories will balloon, and changes in working capital will turn sharply negative.