Working Capital & Cash Flow Interview Questions for Finance

Working capital is defined as current assets minus current liabilities. 

It indicates a company’s ability to cover short-term obligations with short-term resources. 

Positive working capital generally reflects healthy liquidity, while negative working capital can point to potential financing or operational challenges, depending on the industry.

Negative working capital means current liabilities exceed current assets. In many cases, this signals liquidity risk because the company may struggle to cover short-term obligations. 

However, in industries like retail or fast food, negative working capital can be normal and even efficient, since customers pay upfront while suppliers are paid later.

The cash conversion cycle measures how long it takes to turn investments in inventory and receivables into cash. 

A shorter cycle means faster cash generation and stronger liquidity, while a longer cycle indicates capital is tied up in operations.

Increasing DPO means the company takes longer to pay suppliers, which delays cash outflows and temporarily boosts free cash flow. While this improves liquidity in the short term, excessive stretching of payables can harm supplier relationships or credit terms.

This happens when working capital absorbs cash despite reported profits. 

For example, if receivables or inventory rise significantly, cash is tied up even though sales are booked under accrual accounting. Other reasons include non-cash gains (e.g., asset revaluations) inflating net income or one-off timing mismatches between expenses and payments.

In a DCF, free cash flow is reduced by increases in net working capital and increased by decreases in net working capital. 

For example, if receivables or inventory rise faster than payables, cash is tied up, lowering FCF. Conversely, if payables rise or inventory is reduced, cash is released, raising FCF.

The key is that working capital is treated as a use or source of cash in the cash flow statement and directly impacts valuation.

Rapid sales growth often increases the need for working capital, since receivables and inventory rise faster than payables. This can create a cash drain even if reported profits look strong.

• Higher accounts receivable → customers take longer to pay, tying up cash
• Larger inventory → more capital invested in stock before sales convert
• Accounts payable may not grow at the same pace → less offsetting financing
• Net effect: cash flow pressure despite rising revenues

The most informative statement is the Cash Flow Statement, as it shows whether the company is generating enough cash to sustain operations and growth. The Income Statement and Balance Sheet provide important context, but cash generation is ultimately what keeps a business alive.

• Cash Flow Statement: reflects real liquidity and operating cash generation
• Income Statement: measures profitability, but includes accruals and non-cash items
• Balance Sheet: shows solvency, leverage, and resources at a single point in time

All three financial statements are connected, but cash is the strongest indicator of financial health

A company can strengthen its cash position by managing working capital more efficiently and reducing cash outflows. These measures free up liquidity without relying on debt or equity financing.

• Collect receivables faster through stricter credit policies or better collections
• Reduce inventory levels with improved planning and supply chain management
• Extend payment terms with suppliers to keep cash longer
• Sell non-core or underutilized assets
• Postpone or scale back discretionary expenses and investments

Higher depreciation reduces net income because it lowers EBIT. However, since depreciation is a non-cash expense, it is added back in the cash flow statement. The lower taxable income also reduces cash taxes, which means the overall effect is an increase in free cash flow.

Seasonal businesses face fluctuations in receivables, payables, and inventory that create uneven cash flows throughout the year. They typically manage this by building cash reserves during peak periods, using short-term credit facilities to cover off-season gaps, and negotiating supplier or customer terms to better match inflows and outflows.