Understanding What Causes Increases or Decreases in Working Capital
- Ed Patton
- 4 days ago
- 2 min read
Updated: 3 days ago
Working capital is a sound measure of a company’s financial health.
Working capital is easily calculated:
Current assets minus current liabilities = the amount of a company’s working capital.
Many business leaders and their advisers do not understand, and therefore do not report, the drivers of changes in working capital.
A primary reason for this is that the focus is often on changes in working capital components while overlooking the drivers that change the amount of a business’s working capital (i.e., its financial health).
Before evaluating how effectively working capital components are managed, leaders need to understand whether their business generated or consumed working capital (i.e., did the company become financially healthier or financially weaker).
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Foundation Capital and Foundation Cash Flow (FCF)
The drivers of changes in working capital are the changes in Foundation Capital…which the Trender® Platform has termed Foundation Cash Flow.
Foundation Capital is also easily calculated:
Equity plus non-current liabilities minus non-current assets.
(Again…changes in Foundation Capital are termed Foundation Cash Flow.)
The Top Half and the Bottom Half of a Balance Sheet
The top half of a balance sheet (net working capital components) is the same dollar amount as the bottom half of a balance sheet (net foundation capital components).
Financial and business wisdom is enhanced by evaluating the balance sheet relationships — not only the left (assets) and right (liabilities + equity) halves, but also the top and bottom halves.
Top half of balance sheets (Working Capital…home to current assets and current liabilities…primarily consists of cash and “holding tanks” of AR, AP, Inventories).
Bottom half of balance sheets (Foundation Capital…home to non-current assets and non-current liabilities and equity…primary business / economic activities are recorded here).
The top and bottom halves of balance sheets equal each other.
See the following illustration of the top and bottom halves of a balance sheet:
Financial and business understanding is significantly strengthened by grasping the insights and simplicity of FCF.
This article discusses three core concepts every business leader should understand: (1) foundation capital, (2) foundation cash flow, and (3) how these drive changes in working capital – providing a clear view of whether the business became financially stronger or financially weaker.
For a deeper discussion on the strategic value and practical applications of foundation capital, FCF, working capital drivers, feel free to reach out.
The attached Excel spreadsheet is a calculation of a business’s foundation capital and working capital, and the changes in both.
Fill in the light blue colored cells on this spreadsheet to calculate your company's FCF and working capital changes.
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Building confidence in finance starts with comprehending the fundamentals. To explore foundation capital, foundation cash flow, and clear / concise financial basics, reach out for more practical solutions.
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Edward B. Patton
5701 Broadway, Suite 102
San Antonio, Texas 78209
Phone (210) 822-9977
