Working Capital and the Balance Sheet

This entry is part 2 of 3 in the series Working Capital


The conservation-of-value principle says that it doesn’t matter how you slice the financial pie with financial engineering, share repurchases, or acquisitions; only improving cash flows will create value. (Dobbs, Huyett & Koller, 2010).

The above, taken from “The CEO’s guide to corporate finance” will be our starting point and Occam’s razor the tool to simplify the balance sheet using the concept of working- and operating capital.

To get a better grasp of the firm’s real activities we will as well separate non-operating assets from operating assets – since it will be the last that defines the firm’s operations.

To find the amount of operating current assets we have to deduct the sum of minimum cash level, inventories and account receivables from total current assets. The difference between total- and operating current assets is assumed placed in excess marketable securities – and will not be included in the working capital.

Many firms have cash levels above and well beyond what is really needed as working capital, tying up capital that could have had better uses generating higher return than mere short-term placements.

The net working capital now found by deducting non-interest bearing current liabilities from operating current assets, will be the actual amount of working capital needed to safely run the firms operations – no more and no less.

By summing net property, plant and equipment and other operating fixed assets we find the total amount of fixed assets involved in the firm’s operations. This together with net working capital forms the firms operating assets, assets that will generate the cash flow and return on equity that the owners are expecting.

The non-operating part – excess marketable securities and non-operating investments – should be kept as small as possible, since this at best only will give an average market return. The rest of the above calculations give us the firm’s total liability and equity, which we will use to set up the firm’s ordinary balance sheet:

However, by introducing operating-, non-operating- and working capital we can get a clearer picture of the firm’s activities1:

The balance sheet’s bottom line has been reduced by the smallest value of operating current assets and non-interest bearing debt and the difference between them – the working capital – will be an asset or a liability depending on which of them that have the largest value:

The above calculations is an integral part of our balance simulation model and the report that can be produced for planning, strategy- and risk assessment from the simulation can be viewed her; report for the most likely outcome (Pdf, pp 32). However this report can be produced for every run in the simulation giving the opportunity to look at tail events that might arise, distorting expectations.

Simplicity is the ultimate sophistication. — Leonardo da Vinci


Dobbs, D, Huyett, H, & Koller, T. (2010). The ceo’s guide to corporate finance. McKinsey Quarterly, 4. Retrieved from


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  1. Used in yearly reports by Stora Enso, a large international Pulp & Paper company, noted on NASDAQ OMX in Stockholm and Helsinki. []


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