How to Walk Through Working Capital in an LBO Interview

Working capital is where clean LBO stories get dirty. Interviewers ask whether your free cash flow assumes magical inventory turns or ignores the cash a growth company needs to fund receivables. If you can walk ΔNWC with signs, growth effects, and a negative-WC downside, you sound like someone who has underwritten deals.

The short answer

"In an LBO, change in net working capital is a cash use when NWC rises and a source when NWC falls. I forecast NWC from operations, usually as a function of sales for AR, inventory, and AP, then subtract the year-over-year increase from free cash flow. For negative WC businesses, growth can release cash, but I stress an unwind in downside cases."

Where it sits in the FCF bridge

FCF ≈ EBITDA − interest − taxes − CapEx − ΔNWC ± other
(Exact tax/interest order depends on model; be consistent)

ΔNWC = NWC_t − NWC_t−1.
If NWC increases, ΔNWC is positive and cash available for debt paydown falls.

NWC itself is typically operating current assets minus operating current liabilities. Exclude excess cash and interest-bearing debt from the operating WC definition so you do not double count financing items.

Build intuition with signs

Drill the accounting versions on three-statement posts if signs still feel shaky. In the LBO room you need speed: "AR days up five days is a cash use equal to the incremental AR balance."

How to forecast it

Two common methods:

1. % of sales for AR, inventory, AP (simple, interview-friendly)
2. Days methods (DSO, DIO, DPO) tied to the operating case

Either works if you are consistent and can shock days on follow-up. Fancy monthly seasonality is rarely required in a screen; mention seasonality if the business is retail or otherwise peak-driven and a revolver funds the peak.

Growth companies

Fast growth often means:

• More AR and inventory before cash collections catch up
• CapEx plus WC as a double investment
• AP may stretch, but that is not free financing forever

If EBITDA grows 15% but WC and CapEx eat the cash, debt paydown stalls and MoIC/IRR slip. A CIM that shows EBITDA ramps with flat WC needs a reason: mix shift, better terms, or wishful turns.

Negative WC LBOs

Subscription software, certain marketplaces, and some retail models can show NWC as a source while growing because deferred revenue or payables exceed AR and inventory. That is real until growth slows or terms normalize.

Underwrite:

1. Base case with WC benefit while growth continues
2. Downside where growth slows and WC normalizes or unwinds
3. Explicit note that the "cash machine" is partly a timing liability to customers or suppliers

See Negative Working Capital.

Peg at close

Entry sources and uses may assume a working capital peg. That sets the opening NWC you inherit and true-up mechanics with the seller. Do not double count a cash sweep of WC that was never in the locked-box or closing statement. In interviews, say: peg defines Day-1 NWC; your forecast is the change from that base.

Compare: lazy vs disciplined WC

Walk order in the interview

Mini numerical example

Sales $200m. AR is 15% of sales = $30m. Next year sales $230m and AR stays 15% = $34.5m. ΔAR = +$4.5m cash use before inventory and AP. If inventory also scales and AP only partially offsets, Year 1 FCF can lose several million versus a flat-WC toy model. That is enough to change debt paydown and IRR in a tight case. In the room, walk one line item like this so the interviewer sees you can size the plug, not only recite signs.

Seasonality overlay: a retailer may show NWC peaking before the holidays. Annual models can hide a revolver draw that is real credit risk even if year-end NWC looks fine. Mention the peak if the business earns it.

Verbal 30 seconds

"I model AR, inventory, and AP off the operating case, take the change in NWC out of FCF, and I am skeptical of endless turn improvement. Negative WC can fund growth, but I stress the unwind when growth fades. The peg sets opening NWC so I do not invent cash at close."

Follow-ups

1. How would a 5-day stretch in DSO change Year 1 FCF?
2. Seasonal NWC peaks and revolver draws
3. What is in NWC vs net debt at close?
4. What if AP stretch is really deferred CapEx or distressed payables?

Practice

On Project Apollo, shock AR days +5 and narrate the debt paydown change. Pair with Working Capital Interview Questions.