Working capital is the difference between current assets (cash, receivables, inventory) and current liabilities (payables, accrued expenses). Changes in working capital are often the hidden driver of the gap between net income and operating cash flow.
The working capital formula
Working Capital = Current Assets − Current Liabilities
Working Capital Change Impact on OCF: - Receivables increase → cash hasn't been collected → OCF decreases - Inventory increase → cash paid but not yet sold → OCF decreases - Payables increase → you owe money but haven't paid → OCF increases
Common cash flow drains from working capital
Slow collection: A $1M ARR SaaS company invoicing on net-60 terms has ~$165k permanently tied up in receivables (two months of revenue). Switching to net-15 frees $125k in immediate cash without changing revenue.
Inventory build: E-commerce companies building inventory before peak season consume cash months before receiving revenue. Careful inventory planning reduces the working capital trap.
Advance payments: Charging annual plans upfront (subscription in advance) creates negative working capital — you receive cash before recognizing revenue. This is one reason SaaS companies love annual prepayments.
How to improve working capital
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Offer early payment discounts: 1–2% discount for payment within 10 days (net-30) is often economically rational for buyers and dramatically improves your receivable collection.
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Switch to annual billing: moving customers from monthly to annual billing collects 12 months of cash upfront vs 1 month at a time.
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Negotiate supplier terms: extending payables from net-30 to net-60 provides interest-free short-term financing at your suppliers' cost.
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Just-in-time inventory: for physical products, reduce inventory carrying costs by ordering closer to actual demand.
Use the Operating Cash Flow Calculator to model the cash flow impact of working capital improvements.