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Working Capital vs Free Cash Flow: What's the Difference?

When it comes to business financing, it's important to understand the difference between working capital and free cash flow. Both are important measures of a company's financial health, but they're not the same thing. Here's a look at the key differences between working capital and free cash flow.

What is Working Capital?

Working capital is a measure of a company's short-term financial health. It's calculated by subtracting a company's current liabilities from its current assets. A positive working capital means a company has more assets than liabilities, and is in good financial health. A negative working capital, on the other hand, means a company has more liabilities than assets, and is in poor financial health.

What is Free Cash Flow?

Free cash flow is a measure of a company's financial health over the long term. It's calculated by subtracting a company's capital expenditures from its operating cash flow. A positive free cash flow means a company has more cash coming in than going out, and is in good financial health. A negative free cash flow, on the other hand, means a company has more cash going out than coming in, and is in poor financial health.

The Difference Between Working Capital and Free Cash Flow

The key difference between working capital and free cash flow is that working capital is a measure of a company's short-term financial health, while free cash flow is a measure of a company's financial health over the long term. Put simply, working capital is a snapshot of a company's financial health at a given moment, while free cash flow is a more holistic view of a company's financial health.

Why is Working Capital Important?

Working capital is important because it's a measure of a company's ability to pay its short-term liabilities. If a company has a negative working capital, it means it has more liabilities than assets, and may have trouble paying its bills in the short term. This can be a serious problem, as it can lead to a company defaulting on its debts, which can ruin its credit rating and make it difficult to obtain financing in the future.

Why is Free Cash Flow Important?

Free cash flow is important because it's a measure of a company's ability to generate cash over the long term. If a company has a negative free cash flow, it means it's spending more cash than it's bringing in, and may have trouble paying its bills in the long term. This can be a serious problem, as it can lead to a company defaulting on its debts, which can ruin its credit rating and make it difficult to obtain financing in the future.

How to Improve Working Capital

There are a few ways to improve working capital. One way is to increase assets. This can be done by increasing sales, or by reducing inventory. Another way to improve working capital is to reduce liabilities. This can be done by paying off debts, or by negotiating better payment terms with suppliers.

How to Improve Free Cash Flow

There are a few ways to improve free cash flow. One way is to increase operating cash flow. This can be done by increasing sales, or by reducing expenses. Another way to improve free cash flow is to reduce capital expenditures. This can be done by delaying or cancelling plans for new equipment or facilities.

The Bottom Line

Working capital and free cash flow are both important measures of a company's financial health. They're not the same thing, but they're both important. Working capital is a measure of a company's short-term financial health, while free cash flow is a measure of a company's financial health over the long term. Improving working capital can be done by increasing assets or reducing liabilities. Improving free cash flow can be done by increasing operating cash flow or reducing capital expenditures.

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