How does a change in working capital affect free cash flow (FCF)?

A change in working capital directly impacts free cash flow (FCF) because it reflects the cash that a company does or does not have available as it grows. When a company increases its working capital—by extending credit to customers or increasing inventory, for example—this can mean that more cash is tied up in operations, which reduces the amount of free cash flow available. Conversely, if a company decreases its working capital, it can free up cash that can be used for growth or returned to shareholders, thus increasing FCF.

Working capital is a key component in understanding a company's liquidity and operational efficiency. As a company grows, ideally, it should manage its working capital efficiently to ensure that it generates cash flows that support growth initiatives. A change in working capital basically indicates how effectively a company is managing its receivables, payables, and inventory in relation to its revenue growth. Therefore, a positive change in working capital often suggests that the company is generating more cash, while a negative change may indicate cash constraints, highlighting its influence on FCF generation as the company expands.