FP&A Interview Question #24 | What is Working Capital?

Imagine walking into your next FP&A interview fully confident in your technical skills, only to be caught off guard by a seemingly simple question:

“How do you define working capital?”

This question is far more than a test of memorization—it’s a probe into your business acumen and practical understanding of how companies manage their day-to-day operations.

Drawing from insights shared by CA Asif Masani, this article will equip you with a ready-to-use framework for answering this common but critical interview question.

You’ll learn how to go beyond the textbook formula, recognize operational nuances, and demonstrate your ability to analyze and improve working capital in real-world business scenarios.

Understanding Working Capital: More Than Just a Formula

At its core, working capital is often defined as:

Current Assets minus Current Liabilities

While this definition is technically correct, interviewers want to assess if you can interpret what these numbers truly mean for a business. Most candidates can recite the formula, but few connect it to the operational realities behind the figures.

Consider a retail store holding $500,000 in inventory against $300,000 in accounts payable. On paper, this yields a positive working capital of $200,000—a seemingly strong position. But what if half of that inventory isn’t selling? Suddenly, that healthy number masks a looming liquidity problem. This example highlights why interviewers dig deeper: they want to see if you can spot the hidden risks behind the numbers.

Working Capital as a Dynamic Business Measure

Working capital isn’t just a static number; it reflects how efficiently a business operates.

Companies can have positive working capital yet struggle with slow-paying customers or obsolete stock. Conversely, negative working capital isn’t always a red flag. For instance, Amazon strategically operates with negative working capital by collecting payments from customers before paying suppliers.

This approach turns working capital management into a competitive advantage.

What Interviewers Really Want to Know

When asked about working capital, interviewers look for understanding in three key areas beyond the basic formula:

Liquidity of Current Assets: Not all current assets are equally liquid. For example, $100,000 in cash is far more accessible than the same amount locked in slow-moving inventory.
Impact of Payment Terms: How do supplier and customer payment terms affect cash flow timing? Delays in payments or collections can significantly influence liquidity.
Industry-Specific Expectations: Working capital needs vary widely by industry. Retail businesses require different working capital levels compared to software companies or construction firms.

How to Structure Your Answer

Start with the basic definition, then quickly pivot to its interpretation. For example:

“Working capital shows whether a company can cover its short-term obligations while funding growth. The absolute number matters less than understanding its components—for instance, a high working capital figure means little if most assets are tied up in unsold inventory.”

Then, illustrate how you would analyze working capital practically:

Examine the working capital cycle: How quickly does inventory sell? When do suppliers get paid? When do customers settle invoices?
Understand industry norms: A manufacturer might need 60 days to convert materials into cash, whereas a grocery store might do so in just days.
Identify warning signs: Shrinking working capital amid growing sales could signal deteriorating collections or excess stock buildup.

The most impressive candidates go further by explaining how they would improve working capital management:

“I would track key metrics like Days Sales Outstanding (DSO) alongside the working capital cycle. If receivables are slowing down, we might need to enforce stricter payment terms with customers.”

Ultimately, interviewers want to hear that you view working capital as the company’s operating pulse—not just an accounting concept. It answers three critical questions:

Can we pay bills as they come due?
Are we using our resources efficiently?
Does our cash flow support our growth plans?

Case Study: How Bella’s Boutique Nearly Collapsed Despite Positive Working Capital

To bring these concepts to life, let’s examine the real-world example of Bella’s Boutique, a small retailer that appeared financially healthy but faced a near-collapse due to hidden working capital problems.

At first glance, Bella’s Boutique had strong holiday sales and $200,000 of positive working capital on its books. The working capital ratio (current assets divided by current liabilities) was 1.8, comfortably within the textbook “safe” range.

However, the crisis emerged after winter when 80% of that working capital was trapped in unsold winter coats. While the financial statements showed ample current assets, most were not liquid or readily available to pay bills or replenish inventory.

Further analysis revealed that accounts receivable had stretched beyond 60 days—customers were not paying on time. The boutique’s cash flow was about to dry up, putting payroll and vendor payments at risk.

This case highlights a crucial lesson: positive working capital numbers mean little if the assets aren’t liquid when needed. A business can look healthy on paper but be just days away from a cash crisis.

How FP&A Saved Bella’s Boutique

The FP&A team implemented two strategic changes that turned the situation around within three months, freeing up $150,000 in cash without taking loans:

Renegotiated Supplier Payment Terms: Extended accounts payable deadlines to better match the boutique’s slower cash conversion cycle.
Dynamic Inventory Forecasting: Used sales data for precise stock ordering instead of guesswork, reducing excess inventory.

This cash infusion covered two months of operating expenses and came entirely from better working capital management—not from increasing sales or cutting costs.

Industry Nuances: When Working Capital Ratios Break the Rules

The classic working capital ratio range of 1.2 to 2 is a helpful guideline but not a hard rule. Different industries—and even different business models within industries—can operate successfully with ratios outside this range.

Examples of Strategic Working Capital Management

Tesla: Frequently operates with a ratio below 1 because customer deposits come in before cars are built. This prepayment funds operations effectively, making a low ratio a sign of efficient cash management rather than distress.
Software-as-a-Service (SaaS) Companies: Often show negative working capital because customers pay upfront for yearly subscriptions while expenses are recognized monthly. Prepaid subscriptions become a cash advantage.
Construction Companies: Require higher working capital ratios due to long project cycles where materials and labor are paid months before client payments are received. A high ratio here is normal and necessary.

Why Trends Matter More Than Absolute Numbers

The real warning sign is not a low or high ratio itself, but a downward trend without operational justification. For example, if a company’s working capital ratio drops quarter after quarter while sales remain flat, it could indicate:

Piling up receivables due to delayed customer payments
Slowing inventory turnover

Pairing working capital analysis with metrics like Days Sales Outstanding (DSO) and inventory turnover helps reveal the full picture. For example, a tech company might justify a 0.8 ratio with 90-day payment terms to suppliers, but if its DSO jumps from 30 to 60 days unexpectedly, that’s a red flag.

How to Nail This in the Interview

When faced with the question “What is working capital?” in an FP&A interview, don’t just recite textbook definitions or safe ranges. Instead, demonstrate your practical understanding by:

Defining working capital and immediately interpreting what it means operationally.
Explaining how you would analyze the working capital cycle, payment terms, and industry norms.
Providing examples of when unconventional ratios reflect strategic decisions rather than problems.
Discussing warning signs and how you would investigate and address them.
Showing how improved working capital management can free up cash and support growth without relying solely on sales increases or cost cuts.

Final Thoughts

This approach will set you apart from candidates stuck on textbook answers, showing interviewers that you see working capital as the operating pulse of a business—a vital indicator of liquidity, efficiency, and growth potential.

Working capital is a foundational concept in finance, but its true value lies in how it reflects the health and efficiency of a business’s operations. Understanding the liquidity of current assets, the impact of payment terms, and the industry context is essential to interpreting working capital correctly.

Through real-world examples like Bella’s Boutique and industry cases such as Tesla and SaaS companies, it becomes clear that working capital management is about more than numbers—it’s about timing, strategy, and foresight.

Next time you face this question in an FP&A interview, remember: interviewers aren’t just testing your ability to calculate working capital. They want to know if you can use it to keep a business running smoothly and sustainably. Show them you can.

Subscribe to Weekly FP&A Jobs Newsletter (every Wednesday): https://creative-thinker-9463.kit.com/764eca1113

Find out about our Weekly Live Webinars: https://fpnaprofessionals.com/