NPV is the difference between the present value of the incoming cash flows and the present value of the outgoing cash flows. It indicates the current value of a company based on its projected earnings less projected expenses. A positive NPV indicates a profitable investment, while a negative NPV indicates a loss-producing investment. Changes in working capital are an integral component in calculating net cash flow.
Working capital is calculated by subtracting current liabilities from current assets. Current liabilities are a company's obligations that are due within one year. Current assets are corporate resources that are highly liquid.
The most prominent current liability is accounts payable, or money owed to suppliers by the company for goods or services already received. The most prominent current asset is accounts receivable, or money owed to the company from customers who have received, but not paid for, their orders.
Changes in these working capital accounts work to either increase or decrease cash flow. Cash flow increases as accounts receivables decrease or as accounts payables increase. Accordingly, cash flow decreases as accounts receivables increase or accounts payables decrease. Therefore, as working capital changes from period to period, it has an effect on cash flow which, in turn, has an effect on NPV.