Working Capital

Working capital is the difference between current assets and current liabilities, measuring short-term liquidity and ability to meet operational obligations. Current assets include cash, A/R, inventory, and short-term investments; current liabilities include A/P, accrued expenses, deferred revenue, and short-term debt. Positive working capital means more current assets than current liabilities; negative working capital is normal for some business models (subscription companies with annual billing) and concerning for others (companies that owe more than they can collect).

The math:

Working capital = Current assets - Current liabilities

Current assets include:

• Cash and cash equivalents.
• Accounts receivable (A/R).
• Inventory (where applicable).
• Short-term investments.
• Prepaid expenses.

Current liabilities include:

• Accounts payable (A/P).
• Accrued expenses (salaries owed, taxes, etc.).
• Deferred revenue (cash collected but not yet earned).
• Short-term debt and current portion of long-term debt.

A simple example:

A SaaS company has $5M cash, $2M A/R, $1M A/P, $3M deferred revenue. Working capital = ($5M + $2M) - ($1M + $3M) = $3M.

Why SaaS working capital is unusual:

Traditional businesses have positive working capital because they sell products on credit (A/R) but pay for inventory upfront. SaaS companies often have negative working capital because:

• They collect cash upfront (annual billing) → cash piles up but deferred revenue is also large.
• They have no inventory.
• They have steady recurring revenue covering payables.

A SaaS company with $10M cash and $8M deferred revenue has $2M working capital from those two items alone. If the deferred revenue is bigger than the cash, working capital is negative, but the company is healthy because the deferred revenue will convert to recognized revenue over time, not require cash payment.

What working capital signals:

Positive and growing: company has cash buffer and is collecting faster than it spends.

Negative but stable: typical for healthy SaaS with annual billing; the deferred revenue liability represents future revenue, not future cash outflow.

Negative and worsening: company is paying out faster than collecting. Either A/R is climbing, A/P is dropping, or the deferred revenue is being burned without replacement bookings.

Positive but illiquid: working capital positive but mostly inventory or slow-paying A/R. Cash-poor despite the balance sheet.

The working capital cycle (cash conversion cycle):

How long it takes a dollar to go from cash to investment back to cash. See Cash Conversion Cycle for the formal definition.

For SaaS: very fast or even negative cycle (cash arrives before service is delivered).

For inventory-based businesses: typically 30-90+ days (buy inventory, sell, collect).

Why investors and acquirers care:

Working capital is part of valuation: M&A deals often have working capital adjustments (target working capital level set; adjustments at close based on actual).

Working capital changes affect free cash flow: declining working capital (cash converted to fund the business) reduces FCF.

Banks use working capital for credit decisions: lenders look at working capital trends when extending credit.

What founders get wrong: Treating working capital as an accounting concept rather than an operational metric. The right discipline: track working capital monthly; understand the trends in A/R, A/P, deferred revenue; manage cash collection actively (especially as you scale).

Related: Balance Sheet · Cash Flow · Accounts Receivable · Accounts Payable · Deferred Revenue · Days Sales Outstanding

FAQ

What is working capital?
Current assets minus current liabilities. Measures short-term liquidity and ability to meet operational obligations over the next 12 months.

Why is SaaS working capital unusual?
SaaS often has negative working capital because they collect cash upfront (annual billing creates deferred revenue liability). The negative number reflects future revenue obligations, not cash outflows; SaaS can be healthy with negative working capital.

What signals working capital problems?
Working capital declining month-over-month, A/R climbing (customers paying slower), A/P shrinking (paying suppliers too fast), or deferred revenue burning without replacement bookings.

Why do M&A deals have working capital adjustments?
Acquirers set a target working capital level (based on historical normal); the purchase price adjusts at close based on actual working capital. Buyer doesn't want to pay full price for a business with depleted working capital.