When evaluating a new project investment, it is important to consider the net working capital requirements. Working capital refers to the difference between current assets and current liabilities, representing the liquid assets needed to operate the business on a day-to-day basis. The net working capital invested in a project is the incremental working capital needed to support the project’s operations. This is generally not a one-time upfront cost, but rather an investment that is made over the life of the project and is eventually recovered. There are a few key reasons why the net working capital for a project is usually recovered gradually over time:
Working capital needs fluctuate over a project’s life
The working capital needs of a project often vary from year to year, depending on the stage of the project. For example, in early years, more working capital may be needed to stock up on inventories and support project ramp-up. In later years, as operations stabilize, the net working capital needs may decrease. Planning for these fluctuations rather than funding all working capital upfront provides more financial flexibility.
Allows linking of working capital funding to project cash flows
Tying the investment and recovery of working capital to a project’s cash flows over its life cycle allows for better matching of costs to revenue. Rather than a large upfront investment, working capital can be funded in step with project activity, and recovered as excess cash is generated. This reduces the initial cash outlay for the project.
Working capital requirements may decrease over a project’s life
As a project matures and moves down the experience curve, operations often become more efficient. Inventory levels can be reduced, payables extended, and receivables collected faster. This working capital efficiency frees up invested funds over time. Planning for these improvements allows the project to recover working capital it no longer needs.
Enables adjustment to changing business conditions
By retaining working capital on the balance sheet over the course of a project rather than investing it all upfront, the project has the flexibility to adjust the level of investment based on changing business conditions over its life cycle.
In summary, the net working capital invested in a project is generally recovered over the project’s life rather than funded upfront. This approach provides financial and operating flexibility to adjust to fluctuating and improving working capital needs over the project’s lifecycle.