When we talk about working capital in private equity, we may be referring to the financial monitoring value (current assets – current liabilities) or the financial analysis value (current assets – cash – current liabilities). When monitoring a business, we want to know if it is solvent; that is, whether the business can cover its liabilities. Cash is important in this monitoring because it makes up for any shortfall between assets and liabilities as they fluctuate somewhat independently. If working capital turns negative, we immediately know more cash must be injected to make up the shortfall, otherwise the business is at serious risk of bankruptcy. However, when conducting financial analysis (rather than monitoring – such as with working capital calculation), we’re interested in understanding how much cash a business needs to support its operations on an apples-vs-apples basis. That means, we must exclude cash when looking at movements in historical working capital because we want to gauge how much cash would have been needed, not how much was actually in the bank. Just imagine, a company could borrow money, raise equity, sell assets, or any other number of things that can move cash and skew historic analysis of working capital. So, we circumvent these aberrations by conducting analysis on an ex-cash basis. One more point though, an analysis of working capital may only include debtors + inventory - creditors if the analyst wants to understand working capital on a purely operational basis. The difference between this and the current assets - cash - current liabilities method, is that minor current accounts are excluded, such as current debt, prepayments, deposits etc. This may be done to ignore capital structure or if the minor current accounts are insignificant. So please keep all of this in mind when you hear the term working capital. If an accountant asks about working capital, it's likely they're talking about CA - CL. But, if an analyst mentions it, they're likely referring to an ex-cash calculation. One is to gauge solvency and the other is to understand operational cash requirements based on business growth, credit terms and volatility.   Working Capital Series:

1. Introduction
2. References and Calculations
3. Drivers
4. Cash-positive & Cash-negative Profiles
5. Valuation
6. What To Do At Settlement
7. The Locked Box Approach
8. Measuring & Monitoring
9. Improvements & One-off Cash Wins
10. Preparing For Sale