AR, Inventory, AP, and Deferred Revenue, Explained
The question
Explain the cash flow impact of a $10M increase in each of AR, Inventory, AP, and Deferred Revenue. Then, analyze a company where revenue grew 20% but NWC grew 25%. What does that divergence imply, and what specific metrics would you examine to diagnose the issue?
General educational practice only. This is not an actual, confidential, leaked, or firm-provided interview question. Check important technical details against primary learning materials.
Study explanation
An increase in AR uses $10M of cash (cash not yet collected from sales). An increase in Inventory uses $10M of cash (cash paid to build or buy inventory that hasn’t been sold). An increase in AP is a $10M source of cash (you have delayed paying suppliers, retaining cash). An increase in Deferred Revenue is a $10M source of cash (you collected cash from customers before delivering the service or product).
NWC growing 25% while revenue grew only 20% indicates that the company is tying up more capital per dollar of sales, reducing cash efficiency. This could mean slower collections, inventory buildup ahead of demand that may not materialize, or a slowdown in supplier financing.
To diagnose, I would isolate each component: compute DSO (did it rise, indicating collections are worsening?), DIO (is inventory bloating?), and DPO (are payables being stretched or shrinking?). I would also compare the current ratios to historical trends and industry norms.
Follow-up pressure:
- Suppose you discover the inventory build is for a new product launch expected to double next year’s sales. How would that change your interpretation and your forecast?
- If the company is highly seasonal, with most of its sales in Q4, how would you adjust your analysis of the NWC-to-revenue growth divergence?
- What if the revenue growth was entirely driven by one large, slow‑paying customer? How would you reflect that in your DSO and cash flow projections?
Balance sheet
| Cash | 150 |
| Accounts receivable | 120 |
| Inventory | 90 |
| Total current assets | 360 |
| PP&E, net | 400 |
| Goodwill | 150 |
| Other assets | 40 |
| Total assets | 950 |
| Accounts payable | 80 |
| Deferred revenue | 40 |
| Total current liabilities | 120 |
| Long-term debt | 380 |
| Total liabilities | 500 |
| Total equity | 450 |
| Total liabilities & equity | 950 |
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The rest of this topic
Working capital and cash conversion