What happens to Free Cash Flow when Net Working Capital increases?

When Net Working Capital (NWC) increases, it typically represents a greater amount of funds tied up in current assets, such as inventory and accounts receivable, that are necessary for the ongoing operations of the business. This increase in NWC means that more cash is being used to finance these assets rather than being free for other purposes.

Free Cash Flow (FCF) is defined as the cash generated by the business operations that is available for distribution to all capital providers, after accounting for capital expenditures necessary to maintain or expand the asset base. When NWC rises, it implies that cash is likely being consumed to finance additional current assets, thereby reducing the amount of cash available for distribution.

Thus, the relationship between an increase in NWC and Free Cash Flow is inversely proportional. As NWC increases, it absorbs cash, leading to a decrease in Free Cash Flow. This understanding is foundational in analyzing a company's liquidity and operational efficiency.