Working capital explained

What is working capital? Let’s first go through an intuitive example of what high working capital needs and low working capital needs are. Then we cover a definition of working capital, discuss the relationship between #workingcapital and cash, and calculate the working capital balance for two well-known multinational companies. Let’s dive straight in!

⏱️TIMESTAMPS⏱️
00:00 Introduction to working capital
00:25 Working capital example
01:42 Working capital definition
01:59 Working capital and cash
02:43 Working capital case study: 3M
03:26 Working capital case study: Microsoft

Let’s imagine you operate a “buy-stock-sell” business in children’s toys. You buy from your supplier, hold the toys in stock, then sell to customers. Sometimes the product moves through your business at a nice steady pace, sometimes the process has a bit more variability and the pace is a little slower.

What would you prefer as a business owner, assuming the pricing and profit margins are the same between the two scenarios. Would you vote for option A, where you pay your supplier cash on delivery, hold high inventory levels, and grant customers 45 days credit before they need to pay you. Or would you vote for option B, where you have 45 days credit from your supplier, work with “Just In Time” inventory levels, and have your customers pay cash on delivery.

With option A, there is a high working capital, that somehow needs to be financed by debt or equity. With option B, there is a low working capital, reducing the need for financing. With option A, cash flow and return on assets will be lower. With option B, cash flow and return on assets will be higher.

The definition of working capital that we use in this video is: the total amount of capital invested into your company’s operating cycle (day-to-day operations). I believe this is the most useful way of looking at working capital.

What is the relationship between working capital and cash? Let’s say that your children’s toys company decides on three actions: paying suppliers quicker than before, holding more inventory, and granting customers extended terms. This drives working capital up, and cash down, possibly triggering the need to go out for more financing. If however you stretch supplier terms (pay them later), achieve higher inventory turns, and improve the collections of payments from customers, your working capital would decrease, and as a result your cash would increase, possibly increasing the opportunity to pay down loans, or pay dividends.

Philip de Vroe (The Finance Storyteller) aims to make strategy, #finance and leadership enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better investing decisions. Philip delivers #financetraining in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!

[marciamayele]

You explained in 5 minutes a chapter of 50 pages. I will be back here often.

[salmoneous]

You and I, Sir are going to be best friends for the next 8 weeks.

Edit: i've graduated

[JackMajor]

It just clicked for me when you described how third parties are literally financing the operations as working capital with outstanding payables that are unearned revenues in MS' books. Your channel is amazing. Vielen dank!

[TheFinanceStoryteller]

Where did you come across the term "working capital"? Let me know by commenting below!

[Christopher-ycpy]

Great video. Simply, clear, and straight to the point. Thank you!

[piano]

Excellent, direct teaching! It's easy to understand. Thank you.

[bornesmouthbarnsman]

Very informative video as always! I love the real life examples!

[bigzooboss]

i finally understand the true meaning of working capital. thank you!

[maze.p]

Thanks a lot this was super helpful... and every second of the video informative

[raflop]

@3:20 I was always confused about CCC when units were in days. However, seeing in it from the balance sheet in $ units the CCC formula makes much more sense. Thanks.

[shubhamsachdevardias]

Thank you i was suffering in understanding the practical meaning working captial but you made it easy.😇

[konstancyja]

Amazing amount and quality of information! And definitely better than at school

[neb]

Woww I have to read a 30 page article for tomorrow on working capital

You sir just saved the day

[yinyin]

Great teacher. Thanks for producing such high quality video.

[antentoila]

Excellent sir! This video is so useful for my study ❤ thank you so much.

[shreya]

Thank you so much 😊 It cleared my concept

[marcjosephferrer]

it's a really good definition. thank you

[caprepdiaries]

This is my first video on your channel that i have watched. And thank you for giving me this conceptual clarity. Will sure watch the other stuff you have put.
Also I wanted to ask whether there are other channels you recommend who can give such concise understanding of finance concepts. Actually I am a CA student so I really wanna understand the basic concept what I am learning.

[jaleesadavis]

Very helpful video. This really helped me understand.

[pacoquero]

Te daba un abrazo churri, 3 años de carrera de ade y no me enterao hasta que he visto tu video. Ere mas grande que Pellegrini