Why Working Capital Belongs in an Equipment Project Schedule
An equipment project can require cash beyond the purchase price of the equipment. A business may need to hold more inventory, wait longer to collect customer receivables, or receive more supplier credit as the project grows. The cash tied up in these operating balances is part of the project investment. At project closure, the remaining investment may be released when inventory is sold, receivables are collected, and payables are settled.
The central scheduling rule is simple but easy to misapply: an increase in net working capital is a cash outflow, while a decrease is a cash inflow. If the project closes, the schedule must also show recovery of the ending working-capital balance. In the terminal year, both the change during that year and the final recovery matter.
The exact accounts included depend on the forecast. For a basic equipment-investment schedule, use the operating balances specified in the problem. Do not treat an increase in accounts payable as an investment: because payables are subtracted in NWC, a larger payable balance reduces the amount of cash tied up. Keep financing balances, such as interest-bearing borrowing, separate from operating NWC.
From NWC Balances to Cash Flows
Let \(NWC_t\) be the operating net working capital required at the end of year \(t\), before project closure. If the project continues after year \(t\), the cash flow caused by the change from the preceding balance is the negative of that change:
This convention reflects the direction in which cash moves. If required NWC rises from 20 to 27, the project must put an additional 7 into operations, so the cash flow is \(-7\). If required NWC falls from 27 to 20, 7 is released, so the cash flow is \(+7\).
The identity in the definition follows by distributing the negative sign: \(-NWC_T+NWC_{T-1}+NWC_T=NWC_{T-1}\). It says that if the project’s final NWC balance is fully released, the net NWC cash flow in the terminal year equals the balance that was already tied up at the end of the previous year. The final year’s additional investment, if any, is made during that year and then returned at closure.
If NWC is first required at time zero, include \(-NWC_0\) in the initial outlay. The equipment purchase is also a time-zero outflow. For any year, the total project cash flow is the operating cash flow plus the NWC cash flow and any other relevant project cash-flow items. In these examples, no asset salvage is included; any salvage or disposal tax would be a separate item.
Calculate operating current assets less operating current liabilities, using the accounts and dates stated in the forecast.
At time zero, subtract both the equipment cost and any NWC required immediately.
For each year, subtract the increase in NWC; a decrease therefore produces a positive cash flow.
In the terminal year, add the full ending NWC balance as a recovery, in addition to the cash flow from that year’s change.
Add operating cash flow and all project cash-flow components for each date, then verify that the terminal recovery equals the stated ending balance.
Worked Schedules
Worked Example: Equipment Purchase With Three Years of Working Capital
A hypothetical project buys equipment for $120,000 at time zero and operates for three years. There is no asset salvage. Its after-tax operating cash flows are $50,000, $55,000, and $48,000 in years 1, 2, and 3. Inventory, receivables, and payables are forecast as follows. The project closes at the end of year 3 and recovers all remaining NWC. Prepare the project cash-flow schedule.
| Date | Inventory | Receivables | Payables |
|---|---|---|---|
| Time 0 | $18,000 | $12,000 | $8,000 |
| End of year 1 | $24,000 | $16,000 | $10,000 |
| End of year 2 | $28,000 | $18,000 | $11,000 |
| End of year 3, before closure | $20,000 | $14,000 | $9,000 |
Method. First calculate NWC at each date as inventory plus receivables minus payables. Then use the negative change in NWC for each year, adding the full year-3 balance as a separate closure recovery.
At time zero, \(NWC_0=18,000+12,000-8,000=22,000\). At the end of year 1, \(NWC_1=24,000+16,000-10,000=30,000\), so the year-1 NWC cash flow is \(-(30,000-22,000)=-8,000\). The total year-1 project cash flow is \(50,000-8,000=42,000\).
At the end of year 2, \(NWC_2=28,000+18,000-11,000=35,000\). The NWC cash flow in year 2 is \(-(35,000-30,000)=-5,000\), and total project cash flow is \(55,000-5,000=50,000\).
Before closure at the end of year 3, \(NWC_3=20,000+14,000-9,000=25,000\). The year-3 change requires a cash inflow of \(-(25,000-35,000)=10,000\), because NWC has fallen by $10,000. Closure then releases the full $25,000 balance. Thus year-3 NWC cash flow is \(10,000+25,000=35,000\), and total year-3 project cash flow is \(48,000+35,000=83,000\).
The time-zero project cash flow is \(-120,000-22,000=-142,000\). The full schedule is therefore: time 0, \(-$142,000\); year 1, $42,000; year 2, $50,000; year 3, $83,000. Check: the terminal NWC cash flow is $35,000, equal to the year-2 balance of $35,000, as the terminal-year identity requires. The common mistake avoided here is counting only the $10,000 release during year 3 and omitting the additional $25,000 recovered at closure.
Worked Example: Deriving Operating Cash Flow and Including NWC
A hypothetical project purchases equipment for $90,000 at time zero, has a two-year life, and has no salvage. NWC is $14,000 initially, $20,000 at the end of year 1, and $26,000 at the end of year 2 before closure. The project recovers all year-2 NWC when it closes. EBIT is forecast as $24,000 in year 1 and $28,000 in year 2. Depreciation is $15,000 in each year, the tax rate is 25%, and all depreciation tax deductions can be used immediately. Find the annual project cash flows.
Method. Under the stated assumption that taxes are paid on positive EBIT and the depreciation deduction is fully usable, operating cash flow is \(EBIT(1-T)+Depreciation\). This adds back depreciation because it is a noncash expense, while retaining its tax effect. Then calculate the NWC cash flows and closure recovery.
Year-1 operating cash flow is \(24,000(1-0.25)+15,000=24,000(0.75)+15,000=18,000+15,000=33,000\). The year-1 NWC increase is \(20,000-14,000=6,000\), so year-1 project cash flow is \(33,000-6,000=27,000\).
Year-2 operating cash flow is \(28,000(0.75)+15,000=21,000+15,000=36,000\). NWC increases by \(26,000-20,000=6,000\), a cash outflow of $6,000. At closure, the full $26,000 ending balance is recovered. The year-2 project cash flow is therefore \(36,000-6,000+26,000=56,000\).
At time zero, the project pays for equipment and initial NWC: \(-90,000-14,000=-104,000\). The schedule is time 0, \(-$104,000\); year 1, $27,000; year 2, $56,000. Check: the year-2 NWC cash flow is \(-6,000+26,000=20,000\), equal to the year-1 NWC balance. This method avoids treating the entire $26,000 recovery as the only year-2 NWC item or forgetting the separate $6,000 increase during the year.
Worked Example: A Decline in NWC Before Final Recovery
A hypothetical equipment project costs $75,000 and operates for three years, with no salvage. Its after-tax operating cash flows are $22,000, $25,000, and $30,000. NWC is $12,000 at time zero, $18,000 at the end of year 1, $11,000 at the end of year 2, and $16,000 at the end of year 3 before closure. All year-3 NWC is recovered when the project closes. Prepare the cash-flow schedule.
Method. Use \(-\Delta NWC\) in each year and add the year-3 recovery. In particular, when NWC falls in year 2, the negative change creates an inflow.
The initial outlay is \(-75,000-12,000=-87,000\). In year 1, NWC increases by \(18,000-12,000=6,000\), so project cash flow is \(22,000-6,000=16,000\).
In year 2, NWC decreases by \(11,000-18,000=-7,000\). The NWC cash flow is therefore \(-(-7,000)=+7,000\), and total project cash flow is \(25,000+7,000=32,000\).
In year 3, NWC increases by \(16,000-11,000=5,000\), producing a $5,000 outflow. The project then recovers the full $16,000 ending balance. The year-3 NWC cash flow is \(-5,000+16,000=11,000\), so total project cash flow is \(30,000+11,000=41,000\).
The schedule is time 0, \(-$87,000\); year 1, $16,000; year 2, $32,000; year 3, $41,000. Check: the year-2 release is $7,000, and the terminal-year NWC cash flow is $11,000, equal to the balance held at the end of year 2. A decrease in NWC is a cash inflow, not an outflow.
Common Scheduling Errors
The most consequential error is to treat terminal recovery as a substitute for the terminal year’s change in NWC. It is not. The schedule records what happens during the year and then records the release of the ending balance when operations cease.
Other checks help prevent sign and timing errors:
- Subtract payables when calculating NWC. If payables rise while other balances stay fixed, NWC falls and cash is released.
- Use changes, not full balances, for ordinary annual investment. If NWC rises from 14 to 20, the year’s investment is 6, not 20.
- Use the stated closure date. Recover NWC only when the project ends or when the problem explicitly says it is released.
- Keep initial NWC at time zero. If operations require an initial balance, it is part of the initial outlay, not an operating cash flow earned later.
- Keep other terminal items distinct. Asset sale proceeds and any tax on disposal are separate from working-capital recovery.
Check Your Understanding
For each problem, show the NWC calculation and distinguish annual changes from final recovery.
- A one-year project buys equipment for $64,000. Initial NWC is $9,000, year-1 NWC before closure is $13,000, and year-1 operating cash flow is $18,000. The full year-1 balance is recovered at closure. Find the time-zero and year-1 project cash flows. (Answer: time 0, \(-$73,000\); year 1, $27,000.)
- A project begins with NWC of $16,000. At the end of year 1, NWC is $21,000; the project continues, and operating cash flow is $29,000. Find year-1 project cash flow, excluding other items. (Answer: $24,000.)
- At the end of year 1, a project has NWC of $32,000. At the end of year 2 it has NWC of $27,000, then closes and recovers that balance. Year-2 operating cash flow is $44,000. Find year-2 project cash flow. (Answer: $76,000: a $5,000 release from the decrease plus a $27,000 closure recovery, in addition to $44,000 operating cash flow.)
- An equipment project costs $140,000. At time zero, inventory is $14,000, receivables are $9,000, and payables are $5,000. At the end of year 1, the balances are $18,000, $12,000, and $6,000; at the end of year 2, they are $16,000, $10,000, and $6,000. The project closes at the end of year 2 and recovers all NWC. Operating cash flows are $38,000 and $42,000 in years 1 and 2. Find the full schedule. (Answer: NWC is $18,000, $24,000, and $20,000; project cash flows are time 0, \(-$158,000\); year 1, $32,000; year 2, $66,000.)
- An equipment project costs $80,000 and begins with NWC of $10,000. In year 1, inventory is $12,000, receivables are $7,000, and payables are $4,000. In year 2, before closure, they are $10,000, $6,000, and $4,000. EBIT is $20,000 in year 1 and $24,000 in year 2; depreciation is $10,000 each year, the tax rate is 25%, and all depreciation deductions are usable immediately. The project recovers all NWC at the end of year 2. Find the cash-flow schedule. (Answer: NWC is $15,000 in year 1 and $12,000 in year 2; operating cash flows are $25,000 and $28,000; project cash flows are time 0, \(-$90,000\); year 1, $20,000; year 2, $43,000.)