Module I· Three-Statement Mechanics & LinkagesIntermediate
Question
What happens to working capital in the cash flow statement?
Answer
Mechanics
Working-capital changes are booked in the OCF section (indirect method) as reconciliation items between net income and OCF.
Logic
An increase in WC ties up cash → OCF falls. A decrease in WC frees up cash → OCF rises. Concrete signs: Δ receivables (AR) ↑ → OCF ↓ (revenue was booked but no cash collected). Δ inventory ↑ → OCF ↓ (cash tied up in stock). Δ payables (AP) ↑ → OCF ↑ (you owe suppliers more, conserving cash).
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Example
Net income 100, AR +30, inventory +20, AP +10 → Δ NWC = +40 → OCF = 100 − 40 = 60. Key point: fast-growing companies have OCF << net income because of the WC build-up. A classic middle-market stress point — growth without working-capital financing kills liquidity.