What is the impact on free cash flow when net working capital increases?

• A. Free cash flow increases
• B. Free cash flow remains unchanged
• C. Free cash flow decreases
• D. Free cash flow fluctuates

Answer: (C)

When net working capital increases, it typically indicates that a company has invested more in its current assets—such as inventory and accounts receivable—than it has in its current liabilities. This increase in net working capital requires cash outflow, as the company effectively ties up its cash resources in assets that are not immediately liquid.

Free cash flow is defined as the cash generated by the company after accounting for capital expenditures needed to maintain or expand its asset base. Since an increase in net working capital represents a use of cash, it reduces the amount of cash available for distribution to investors or for other operational needs. Therefore, when net working capital increases, free cash flow decreases because cash is being allocated to working capital instead of being available for other uses.

In summary, an increase in net working capital signifies a cash outflow that directly reduces free cash flow, making it the correct response in this context.