Why Working Capital Increases While Cash Remains Short

There are companies where sales increase and current assets on the balance sheet grow larger, yet cash falls short when the settlement date arrives. To understand this situation, you must first change the habit of using working capital and cash as interchangeable terms. In general financial analysis, net working capital is the amount obtained by subtracting current liabilities from current assets, and current assets include not only cash but also accounts receivable and inventory. Even if short-term assets appear ample on the books, whether they turn into cash on the required date is a separate matter.

An introductory guide to financial statements provided by the U.S. Securities and Exchange Commission explains working capital as the difference between current assets and current liabilities. This article treats net working capital in accordance with that definition. In practical business, items excluding cash or borrowings are sometimes analyzed separately under the name of operating working capital, so when comparing different reports, it is important to align the accounts included in the calculation before looking at the names. This is because different amounts can be derived under the same expression of working capital.

A positive working capital means that current assets are greater than current liabilities on that balance sheet. This is not a guarantee that all liabilities can be paid off immediately at any time. It may take time to sell inventory and collect accounts receivable, and the maturity of liabilities to be paid may arrive earlier than that. Working capital is an indicator summarizing short-term financial structure, but it does not encapsulate the timetable of solvency in a single number.

Even with the Same Working Capital, Different Asset Compositions Behave Differently

For example, assuming the monetary unit is in millions of KRW and both companies have current assets of 100 and current liabilities of 60, the net working capital is 40 for each. However, while the current assets of the first company consist of 60 in cash, 20 in accounts receivable, and 20 in inventory, the other company may hold 10 in cash, 50 in accounts receivable, and 40 in inventory. Even if the totals and working capital are the same, the scale of cash immediately available for payment differs. This difference is why one must look down from the sum of balances to the constituent items.

If the accounts receivable of the second company are collected soon as scheduled and inventory is also sold quickly, the current low cash balance may be temporary. Conversely, if collection is delayed and inventory remains for a long time, the pressure on the payment schedule increases significantly. When comparing two companies with the same number 40, the readability of the collectibility of receivables and the salability of inventory gives it actual meaning. The size of assets and the speed at which assets turn into cash are distinct pieces of information.

The current ratio does not completely resolve this structure either. This is because both companies above have the same value under the method of dividing current assets by current liabilities. Calculating one more ratio does not automatically increase information about asset composition. Because financial ratios are tools that compress items, unfolding and rereading the information lost during the compression process increases the resolution of judgment.

This is also why it is difficult to determine an appropriate level of working capital as a single amount or ratio independent of the industry. A business that needs to secure goods in advance and a business that manufactures after receiving an order require different inventories, and a business that receives money immediately upon sale versus one with many transactions on credit require different roles for accounts receivable. When selecting comparison targets, the business transaction flow and payment terms must be placed together so as not to mistake differences in financial structure for performance differences.

Sales May Enter the Income Statement First, While Cash Arrives Later

Goods sold on credit are recognized as sales, but cash does not come in until the payment is collected. In the meantime, accounts receivable remain on the books. This is why receivables can increase together in a company where sales are growing rapidly. When evaluating sales performance, looking only at revenue may look like successful growth, but for the treasury manager, it can become a structure requiring additional funds equivalent to the payment period provided to customers.

For example, in a contract where goods are delivered and payment is received two months later, if raw material payments must be made one month later, the company must absorb the funding gap between the two points in time. As sales increase, the amount needed for this gap can also grow. This means that even in a profitable transaction, cash is needed first due to the sequence of payments and collections. At this point, the problems to be solved are specifically divided into whether to reduce sales, change collection terms, or secure short-term funds.

In accounts receivable analysis, the composition of overdue receivables is as important as the total balance. Bundling receivables within payment terms and those past due date together fails to distinguish between scheduled collections and delayed collections. By dividing maturity and delinquency periods by customer, one can check how the payment delays of certain clients affect the overall funding plan. It also becomes clearer through this process whether the increase in receivable balances is due to normal growth.

Measures to reduce receivables may entail trade-offs in sales. Early payment discounts can advance cash inflows while reducing the profit left from sales, and changing payment terms excessively strictly can affect customers' purchasing choices. Therefore, rather than setting collection speed as the sole improvement goal, it is more rational to evaluate discount costs and customer relationships together. This is a method of comparing the time of funds and the profitability of transactions on the same table.

Inventory Is Both a Preparation Tool for Sales and a Place Where Cash Resides

Securing inventory allows companies to respond to customer orders, but funds invested in purchase or production can be tied up until sold. This is why it is difficult to evaluate the mere fact that inventory has increased as a good or bad change. Goods secured systematically ahead of peak season and goods remaining unsold beyond expectations have different characters even for the same inventory increase. The difference is revealed only when the receipt timing and sales plan are placed next to the quantity and amount.

The basic formula for inventory turnover is dividing the cost of goods sold for the period by average inventory. Mixing it with other formulas that put revenue in the numerator will change the comparison results, so the definition of the indicator must be standardized. The SEC's introductory guide also explains it using the cost of goods sold and average inventory. Here, average inventory is a value approximating the scale of inventory during the period, often using the average of beginning and ending balances.

For example, if beginning inventory is 20, ending inventory is 30, and the cost of goods sold for the same period is 100, the simple average inventory is 25 and the turnover is 4 times. Using only the ending inventory of 30 as the denominator in this calculation yields a different result. Expressing quarterly cost of goods sold as if it were an annual turnover is also changing the benchmark. Indicating the period and the average calculation method together can reduce confusion where different departments look at the same indicator and make different calculations.

In some cases, the average of beginning and ending does not sufficiently explain the movement of inventory during the period. For a business where inventory accumulates intensively at a specific time and then drops, the change between the two points can be masked in the average. Adding monthly balances or item-by-item inbound and outbound information can locate sections where cash was tied up for a long time. Simple indicators serve rapid comparisons, while detailed records serve root cause analysis.

Supply stability is also addressed during the process of reducing inventory. In items where demand is inconsistent or supply takes time, reducing inventory excessively creates the possibility of failing to meet delivery dates. Conversely, allowing the same margin for all items allocates funds even to slow-selling products. By dividing sales speed, procurement lead time, and the impact of stockouts by item, you can specifically distinguish inventory to be reduced from inventory to be maintained.

Accounts Payable Increases Come with Payment Dates Attached

Accounts payable arise from transactions where goods or raw materials are supplied first and payments are made later. If settlement is pushed back, the company can hold cash during that period, but the obligation to pay does not disappear. Therefore, even when the cash situation improves immediately due to an increase in accounts payable, it must be read in connection with when and to which trading partners payments must be made. Next month's payment burden and today's balance improvement can be two sides of the same transaction.

Increasing accounts payable raises current liabilities in the working capital formula, reducing net working capital. However, in actual transactions, cash can be preserved as payment is delayed. This is another case where a decrease in working capital cannot be directly translated into a cash shortage. Changes in the financial position shown by formulas and changes in cash shown by cash-in and cash-out timings do not always move in the same direction.

The strategy of extending payment terms involves relationships with suppliers. Negotiations to change agreed conditions and acts of delaying payment past the due date are different. Funding plans must be established based on the payment dates allowed by contracts to be stably repeated. If overdue payments incurred to secure short-term cash lead to delivery suspensions or changes in transaction terms, it is difficult to calculate only the effect of cost savings as performance.

Accounts receivable, inventory, and accounts payable are easily managed by separate departments even within the same company. Sales may judge based on revenue and customer terms, procurement based on supply prices and payment terms, and production based on inventory and delivery dates. Given that each department's decisions combine to create the cash gap, working capital management is not just the task of the finance team. It is also the work of coordinating how different goals meet in the company-wide cash flow.

The Statement of Cash Flows Connecting Profit and Loss to Cash

The income statement shows profit through revenue and expenses over a specific period, whereas the statement of cash flows shows the paths through which cash entered and left. The SEC guide explains cash flows by dividing them into operating activities, investing activities, and financing activities. Using this classification, one can read cash increases through different paths—whether they are due to money received from customers, asset disposals, or borrowings and capital raising.

When examining operating cash flow through the indirect method, one starts from net income and adjusts for non-cash items and changes in operating-related assets and liabilities. This is because there are items like depreciation that are reflected in expenses but do not match cash outflows for the period, as well as items like credit sales that are reflected in profits but not yet collected. Reading this connection process can account for why profits were made yet cash from operations was low, categorized by account.

In investing activities, cash used to purchase equipment or cash received from disposing of assets may appear. One cannot judge that operating activities have deteriorated just because total cash decreased during a period of heavy facility investment. Conversely, it cannot be viewed that core cash generation has improved just because cash increased through asset sales. Taking the increase or decrease of cash balances as a starting point, dividing their paths distinguishes the impacts of business operations and investments.

The same principle applies when cash inflows increase due to increased borrowings in financing activities. The fact that cash increased differs from the fact that the company generated funds itself from operations. When cash decreases due to the repayment of borrowings, debt may decrease alongside it. Therefore, rather than a simple evaluation of whether cash has increased or decreased, seeing how borrowings and repayments change future payment burdens is more useful for business judgment.

Plans That Change Transactions Rather Than Goals That Change Numbers

Whether the analysis scope is consolidated financial statements or separate financial statements is another item to align before comparison. Mixing the balance of a single legal entity with balances including multiple entities makes it difficult to tell whether changes in working capital arose from transactions or scope. Calculating with the same period and scope and then explaining changes makes it easier to connect actual cash inflows and outflows managed by treasury managers with financial statement numbers. The unit—whether in KRW or thousands of KRW—must also be displayed together to prevent scale confusion.

When setting working capital improvement goals, it is better to first find out in which transaction processes cash stays the longest. If receivables are the problem, causes differ depending on whether billing is delayed, customers exceed terms, or contracts themselves allow long payment terms. If inventory is the problem, responses vary depending on whether purchase units are large, production schedules misalign with sales, or demand for specific items decreases. Even with the same balance reduction goal, execution methods differ.

Methods for measuring improvement effects are better when specific. Cash secured from a single inventory disposal and fund demand reduced through repetitive order method changes have different persistence durations. Distinguishing whether collection improvement is the result of clearing long-standing receivables temporarily or faster billing procedures helps judge whether the same effect can be expected next quarter. Repeatable transaction processes rather than balances at a single point in time explain the persistence of performance.

In regular treasury meetings, placing scheduled deposit dates and payment dates on the same calendar is helpful. Even if deposits exceed payments overall for the month, if large expenditures concentrate at the beginning of the month and deposits arrive at the end of the month, intermediate funds are needed. Daily plans show time gaps that working capital balances alone fail to reveal. At this point, displaying confirmed deposits and deposits still under negotiation separately clarifies the scope of usable cash.

Working capital is the starting point for understanding the funding structure necessary for companies to continue daily transactions. Although the formula of the difference between current assets and current liabilities is simple, its actual meaning varies depending on the composition and time of cash, receivables, inventory, and payables contained within it. Rather than deciding business health solely on positive or negative judgments, reading which assets turn into cash when and which liabilities fall due first leads to concrete solutions.

Even in situations where sales growth leads to cash shortages, questions are organized around the same flow: When are goods bought or made, when are they sold, when are payments collected, and when are suppliers paid? Understanding this connection allows us to speak on how to adjust contract terms, inventory plans, and billing procedures instead of issuing abstract orders to reduce working capital. What management needs is not the improvement of a single number, but a cash structure that can continuously sustain profitable transactions.