Working capital
Read firstAccrual vs cash. Valuation without accounting is memorization.
Most people meet as a definition to memorize, which is why most people cannot use it. Try it the other way. Target Corporation carried $20,005M of current assets against $21,230M of current liabilities at the end of fiscal 2025. That is negative $1,225M of working capital, and a textbook would call it a warning. It is the opposite.
Target Corporation, Form 10-K for Fiscal 2025, balance sheet at 2026-01-31.
What working capital measures in a model
The operating definition, which is the one that matters, excludes cash and debt. Those are financing. What is left is the money stuck in the machinery of doing business: goods you have paid for and not sold, sales you have made and not collected, and bills you have received and not paid.
The change that shows up on the cash flow statement
The sign is where everyone slips. An asset going up uses cash. A liability going up provides it. sitting on a shelf is money you already spent, and an unpaid supplier invoice is an interest-free loan.
The cash conversion cycle, on the running example
Cash conversion cycle
| FY2025 | |
|---|---|
| Days inventory outstandingInventory / cost of sales x 365 | 59.5 |
| Days sales outstandingA retailer collects at the register, so receivables from customers are near zero | 0.0 |
| Days payable outstandingAccounts payable / cost of sales x 365 | 61.0 |
| Cash conversion cycle | negative 1.5 |
ConventionThese use ending balances rather than an average of beginning and ending. Averages are more defensible when a balance moved a lot during the year, and ending balances are easier to reproduce from one filing. Whichever you pick, say which, because the two answers differ by several days.
How to forecast it
In a model, do not forecast the balance directly. Forecast the days, then derive the balance from revenue or . Inventory at 59 days of cost of sales scales automatically when the forecast grows, and it forces you to state whether you think the business gets better or worse at converting cash.
The lazy alternative, working capital as a fixed percentage of the change in revenue, is what the sandbox uses and it is a real simplification. It is fine for a stable business and wrong for one whose terms are changing. Say which one you are modeling.
Test yourself
01A company's days sales outstanding goes from 45 to 60 while revenue is flat. What happened and what does it cost?
Collections slipped by 15 days, so 15 days of revenue moved out of cash and into receivables. On $365M of annual revenue that is $15M of cash, once. The income statement does not move at all. The follow-up is why it happened: the company extended terms to win business, a large customer is in trouble, or the billing function broke. Those have very different implications and the ratio cannot tell you which.
02Should cash be included in working capital?
Not in the operating definition used in a model. Working capital there means the operating assets and liabilities that fund the business day to day: receivables, inventory, payables, accruals. Cash and short-term debt are excluded because they are financing, and including them would mean a company that raises debt appears to have better working capital. The textbook definition of current assets less current liabilities does include cash, which is why the two figures rarely agree.
03Why is a negative cash conversion cycle a competitive advantage?
Because the business is funded by its suppliers rather than by its investors. Every incremental dollar of sales generates cash before it consumes any, so growth is self-financing. It also concentrates power: suppliers extending 60-day terms to a large retailer are lending it money, and they do that because they cannot afford to lose the shelf space.
A tutor that knows this lesson. It asks before it explains, and it will not tell you what to do with your own money.
Every figure in this lesson that names a company comes from Target Corporation's Form 10-K for Fiscal 2025, the year ended 2026-01-31, filed 2026-03-11. Educational material, not investment advice.