Introduction
Microsoft earned $101.8 billion of net income in its fiscal year ended June 2025. Along the way, its receivables rose by $10.6 billion, absorbing cash, while customers' advance payments added $5.4 billion of deferred revenue (Microsoft's balance sheet calls it unearned revenue) and other current liabilities grew by $5.9 billion, both providing cash. None of those movements changed Microsoft's profit. All of them changed its cash. Together, the changes in operating assets and liabilities, a few long-term lines included, took about $5.4 billion off operating cash flow.
Each line records a timing difference: revenue or expense recognized in one period with the cash arriving or leaving in another. Receivables are revenue before cash; payables and accruals are expense before cash; prepaid expenses are cash before expense. Tracing one transaction of each kind through the statements, with the method from tracing a transaction through the statements, shows why they move cash in the directions they do.
One Rule for Every Working Capital Line
Every operating asset and liability follows the same rule on the cash flow statement, explained from the statement's side in working capital on the cash flow statement:
- An operating asset rises: cash is lower than profit suggests, because the company has recognized revenue it has not collected, or paid cash for a cost it has not yet expensed. The increase is subtracted.
- An operating liability rises: cash is higher than profit suggests, because the company has recognized an expense it has not paid, or collected cash for revenue it has not yet earned. The increase is added.
Decreases work in reverse. The rule follows from the balance sheet: if cash and an operating asset are both assets, and profit and liabilities are unchanged, then more of one means less of the other.
- Working capital
Current assets less current liabilities. In banking analysis it usually means the operating part: the assets a business needs to run day to day, such as receivables, inventory and prepaid expenses, less its operating liabilities, such as payables, accrued expenses and deferred revenue, with cash and debt left out. Changes in working capital, together with non-cash items, reconcile net income to operating cash flow.
Receivables: Revenue Before Cash
A sale on credit creates revenue immediately and cash later. Suppose a services company bills a client $100 for work completed, payable in 30 days, with a 25% tax rate and tax paid in cash:
Net income rises by $75, but cash falls by $25: the company has paid tax on revenue it has not yet collected. The cash flow statement subtracts the $100 increase in receivables to remove the uncollected revenue. When the client pays, cash rises $100 and receivables fall $100, with no income statement effect. Over both periods, cash rises by $75, the same as net income; working capital only moves the cash between periods.
Credit Losses
Some customers never pay. Under the current expected credit loss (CECL) model in Accounting Standards Codification (ASC) 326, companies estimate expected credit losses on receivables and record an allowance, a reduction of the receivable balance, with credit loss expense on the income statement. The details are in accounts receivable and credit losses.
For US tax purposes, most companies cannot deduct an allowance; they deduct a bad debt only when a specific account becomes wholly or partly worthless, since the reserve method was repealed for most taxpayers in 1986, as the Treasury's report on bad debt deductions explains. The book expense therefore comes before the tax deduction and creates a deferred tax asset.
Expenses Before and After Cash
On the cost side, two kinds of timing difference mirror each other. Payables and accruals record expenses that have not yet been paid; prepaid expenses record payments for costs that have not yet been expensed.
Payables and Accrued Expenses
An accounts payable arises when a supplier has invoiced the company; an accrued expense arises when the company has incurred a cost, such as wages earned by employees or interest on a loan, before any invoice or payment. The difference matters for presentation, as explained in accounts payable and accrued liabilities, but the three-statement effect is the same. Suppose employees have earned $40 of wages by year end, to be paid next week:
Net income falls $30, yet cash rises $10, the tax saving, because the wages themselves have not been paid. Next week, paying them reduces cash and accrued expenses by $40 with no effect on profit. A supplier invoice for $40 of utilities, recorded as a payable instead, traces identically.
Prepaid Expenses
A prepaid expense reverses the order: cash leaves first and the expense follows. Suppose a company pays $120 for twelve months of insurance four months before its year end, so $40 of the cover has been used when the books close:
Net income falls by $30, the after-tax cost of the four months used, but cash falls by $110: the full $120 paid, less the $10 of tax saved. The $80 of unused cover sits on the balance sheet as an asset and will be expensed over the next eight months, reducing net income each month without any further payment to the insurer. How prepaid balances are presented and analyzed is covered in prepaid expenses and other current assets.
Microsoft's Working Capital in Fiscal 2025
Microsoft's fiscal 2025 cash flow statement shows the same mechanics at scale:
| Line item | FY2025 |
|---|---|
| Accounts receivable | (10,581) |
| Inventories | 309 |
| Other current assets | (3,044) |
| Other long-term assets | (2,950) |
| Accounts payable | 569 |
| Unearned revenue | 5,438 |
| Income taxes | (38) |
| Other current liabilities | 5,922 |
| Other long-term liabilities | (975) |
| Net change in operating assets and liabilities | (5,350) |
Source: Microsoft fiscal 2025 Form 10-K. Net income was 101,832 and net cash from operations was 136,162.
Receivables absorbed the most cash, consistent with revenue growth from large enterprise and cloud customers who pay on credit terms. Unearned revenue, the cash customers pay in advance for subscriptions and services, provided most of the offset; its three-statement mechanics are traced in deferred revenue on the three statements. The net figure of minus $5.4 billion is small against $136.2 billion of operating cash flow, which is typical of a company whose customers prepay for much of what they buy.
What Bankers Read in the Working Capital Lines
Bankers look at working capital for direction, size and cause. Receivables growing faster than revenue can signal looser credit terms, customers paying more slowly, or revenue recognized ahead of collection. Payables growing faster than purchases can signal a company stretching its suppliers or using supplier finance programs. Prepaids and accruals are usually smaller but can move sharply around insurance renewals, bonus payments and tax installments. The ratios used to track the larger lines, days sales outstanding (DSO), days inventory outstanding (DIO) and days payables outstanding (DPO), are explained in DSO, DIO and DPO.
Working Capital in a Forecast
The same mechanics drive projections. A model usually sets each balance as a number of days of the related income statement line, so the balance grows with the business and the change flows through the cash flow statement. A company with $1,000 of revenue and receivables of 45 days carries about $123 of receivables; if revenue grows to $1,200 and the days stay at 45, receivables rise to about $148, absorbing roughly $25 of cash even though nothing about collections has changed. Shortening the days to 40 would hold the balance to about $132, freeing about $16 of cash compared with the 45-day case. Small changes in days assumptions can therefore move projected free cash flow by more than changes in margins.
The trace itself gives the most useful habit: for every working capital line, ask whether the profit has been recognized before or after the cash. Revenue ahead of cash and cash spent ahead of expense absorb cash; expenses ahead of payment and cash collected ahead of revenue provide it. Over time the differences reverse, which is why net income and operating cash flow converge for a stable business, and why a persistent gap between them is always worth explaining.
