How to Talk About Working Capital in a Private Credit Interview

Working capital is one of the most under-prepared topics in private credit interviews. Candidates know the formula. They can define DSO and DPO. But very few can explain how working capital dynamics actually affect a lender's risk — or why a business that looks profitable on paper might be burning cash.

Working capital is where the gap between EBITDA and cash flow lives. For a lender holding a loan for five to seven years, understanding how cash moves through the operating cycle is not optional — it is the difference between a credit that performs and one that quietly deteriorates.

Why the Lender Cares More Than the Equity Investor

Equity investors model working capital as a percentage of revenue and move on. They care about growth, margins, and terminal value. Working capital is a line item in the bridge — important, but not the focus.

For the lender, working capital is a direct claim on cash flow. Every dollar tied up in receivables or inventory is a dollar that is not available to service debt. And working capital dynamics can create nasty surprises in exactly the scenarios where the lender is most vulnerable — rapid growth, seasonal peaks, and downturns.

Three dynamics matter most:

The Growth Trap

A growing business needs more working capital. As revenue increases, the company carries more receivables (customers owe more), holds more inventory (to support higher volume), and may not receive proportionally better terms from suppliers.

This working capital absorption is a use of cash that reduces free cash flow even as EBITDA is growing. A business growing 15% per year with 60 days of receivables and 45 days of inventory might absorb $5-10M of cash annually in working capital growth. That is $5-10M that is not available for debt service.

The lender's question: "Is the business self-funding its growth, or does the growth require additional liquidity that competes with debt service?"

The Seasonal Squeeze

Seasonal businesses can have massive intra-year working capital swings. A retailer building inventory for Q4 might need $20-30M of incremental working capital in Q3 that releases in Q1 when the inventory converts to receivables and then cash.

On an annual basis, the working capital might net to zero. But within the year, the cash demands can be enormous. If a debt service payment falls during the build period, the business might need to draw on its revolver — or worse, may not have sufficient liquidity.

The lender's question: "When are the cash flow peaks and troughs within the year, and does the liquidity structure (revolver size, cash reserves) accommodate the seasonal swing?"

The Downside Dynamic

In a revenue decline, working capital dynamics cut both ways:

The positive: receivables collect, inventory draws down, and cash is released. This provides a temporary cushion that makes cash flow look better than the operating reality during the first few quarters of a downturn.

The negative: this release is one-time. Once the lower working capital level is established, there is no further release. And if the company has been stretching payables (paying suppliers in 90 days instead of 30), suppliers may tighten terms during a downturn — when they see the borrower's financial health weakening — creating an unexpected cash drain at exactly the wrong time.

The lender's question: "Is the working capital release in the downside case sustainable, or is it masking a temporary cash flow benefit that reverses?"

Key Metrics to Know

Days Sales Outstanding (DSO) — How many days of revenue are tied up in receivables. Higher DSO means more cash tied up. Trend matters: rising DSO may indicate collection problems or customer quality deterioration.

Days Payable Outstanding (DPO) — How many days the company takes to pay suppliers. Higher DPO means the company is using trade credit as free financing. But extremely high DPO (90+ days) can be a red flag — it may signal the company is stretching payments because it lacks cash.

Days Inventory Outstanding (DIO) — How many days of COGS are held in inventory. Higher DIO means more cash tied up in stock. Rising DIO may indicate slow-moving inventory or overbuilding.

Cash Conversion Cycle (CCC) = DSO + DIO — DPO. This measures the number of days between paying for inputs and collecting cash from customers. A shorter CCC is better — cash moves through the business faster.

In an interview, use these metrics to support your analysis, not as standalone answers. Saying "DSO is 65 days" is a fact. Saying "DSO has increased from 50 to 65 days over three years, which suggests either deliberate extension of terms to win business or deteriorating collection quality — either way, it means more cash is trapped in receivables and the cash conversion rate is declining" is analysis.

Common Interview Questions

"How does working capital affect your credit analysis?"

"Working capital is the bridge between EBITDA and actual cash. I look at three things: the cash conversion cycle and whether it is stable or deteriorating, the seasonal pattern and whether liquidity accommodates the intra-year swings, and what happens to working capital in a downside — whether the release is real or temporary. A business can have strong EBITDA and still be cash-constrained if working capital absorbs too much."

"This business is growing 20% per year. What concerns would you have?"

"Growth is positive for the equity story, but for the lender, I want to understand how that growth is funded. Rapid growth typically requires working capital investment — more receivables, more inventory. If the business is converting only 50% of its incremental EBITDA to free cash flow because the rest is absorbed by working capital, the effective debt service capacity is lower than the headline EBITDA suggests. I would model the working capital build explicitly and check that coverage holds after accounting for it."

"The company's DPO is 90 days. Is that a concern?"

"Yes, potentially. A DPO of 90 days means the company is funding itself with trade credit — paying suppliers three months after receiving goods. This is effectively free financing, but it is fragile. If the business weakens, suppliers may demand faster payment or cash on delivery. That reversal — from 90-day payables to 30-day payables — would create a massive one-time cash outflow. I would stress-test this: what if DPO normalizes to 45-60 days? What is the cash impact, and can the revolver absorb it?"

The Working Capital Red Flags

When reviewing a credit, watch for these signals:

• DSO rising faster than revenue growth — suggests the company is extending terms to win business, or collection is deteriorating
• DPO significantly above industry norms — suggests the company is stretching suppliers, which creates reversion risk
• Inventory building without corresponding revenue growth — may indicate slow-moving product or overproduction
• Working capital as a percentage of revenue increasing — the business is becoming less capital-efficient
• Negative working capital presented as a permanent feature — businesses with negative working capital (DPO > DSO + DIO) are essentially funded by suppliers. If that dynamic reverses, the cash impact is sudden and severe

Connecting to the Broader Credit Analysis

Working capital analysis feeds directly into several other areas of your preparation:

• Cash flow analysis — working capital is a key component of the EBITDA-to-FCF bridge. See Cash Flow Analysis for Private Credit.
• Debt sizing — working capital absorption reduces the cash available for debt service, which may lower the maximum supportable debt. See How to Size Debt.
• Downside analysis — working capital dynamics in a downturn can help or hurt cash flow. You need to model both. See How to Analyze Downside Risk.

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The Free Credit Investment Memo Framework includes working capital analysis as part of the cash flow assessment section. Download it to practice integrating working capital into your credit analysis. For 80 model answers including working capital questions, see the Private Credit Interview Guide.