Advanced Finance

Modelling Working Capital Properly

Stop driving working capital off a percentage of revenue — and start building the schedule that actually determines how much cash your growth case consumes.

  • Advanced
  • 8 min total
  • 12 chapters

What decision this helps you make: Which driver and which denominator each working capital line gets, whether to model annually or monthly, and how large the revolver has to be to survive the peak rather than the average.

What this topic is

Working capital modelling is the discipline of forecasting receivables, inventory, payables, prepaids, accruals and deferred revenue from days-based drivers tied to the correct denominator, then feeding the year-over-year change into the cash flow statement as the cash it really is.

Why it matters

The change in net working capital is usually the single largest non-operating swing in a forecast, and it is the line that decides whether a growth case needs a revolver, a term loan, or an equity cheque. Get the drivers wrong and the model produces a confident number that is wrong by millions.

Who should learn it

Anyone who builds or reviews three-statement models, LBO models, or deal cases — analysts, CFOs, lenders sizing facilities, and buyers negotiating a working capital peg.

What you will understand

  • Assign each current asset and liability its correct driver and denominator
  • Compute the cash that growth consumes, from days to dollars
  • Model seasonality well enough to size a revolver for the peak
  • Handle the circularity working capital creates with the revolver and interest

Prerequisites

Common misconception

"Working capital is about 15% of revenue, so I will forecast it that way." That single assumption silently fixes your DSO, your inventory turns and your payment terms to whatever they happened to be in the base year, then holds them constant through every scenario you run. Change the gross margin and payables move for no reason. Change the mix and inventory moves for no reason. The percentage-of-revenue shortcut is not a simplification of the right model — it is a different model, and it is wrong in exactly the scenarios you built the model to test.