Subject: Financial Management
Chapter 7: Working Capital Management
Similar to this is the entire objective of working capital management –
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Manage all the components of working capital in an efficient manner
so that
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We do not run out of cash or materials;
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We are able to cut down process time;
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Hold optimum level of finished goods
and
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Collect money from debtors without carrying receivables longer than necessary.
In short manage all the components efficiently. Hence working capital management has the following components:
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Cash management
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Inventory management
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Creditors management
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Bank finance management
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Receivables management
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Short-term excess liquidity management by investment in short-term securities
Why should current assets be greater in value than current liabilities?
Current assets include receivables that include profit. Further inventory excepting materials, components that arebought out and consumables would be valued after value addition. For example, work in progress and finishedgoods would be higher in value than the materials that have gone into them; whereas the current liabilities would beat cost and hence less in value than the value of current assets. Further the value of current assets is always expectedto be higher than the value of current liabilities as the difference represents the net liquidity available in the businessenterprise.In other words, let us say that current liabilities for a firm are Rs. 100 lacs and the current assets are Rs. 80 lacs. Thismeans that the net working capital is negative and that the enterprise does not have any liquidity. This is a verydangerous situation. An examination of the current assets as above would reveal that all the current assets are not thesame in the context of convertibility into cash. While some of them like inventory of materials, components, work-in-progress cannot be converted into cash immediately; the debtors outstanding (unless it happens to be bad debts)could be converted into cash with a little more ease.Thus can we differentiate between some current assets and others in the context of liquidity? Yes. Those assets thatcan be converted into cash without difficulty are known as “liquid assets”. They are:
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Cash on hand
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Receivables (conventional thinking whereas in reality, there could be some percentage of debtors that cannot beconverted into cash easily)
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Investments that can be converted into cash immediately like investment in limited companies whose shares arelisted on stock exchanges
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Bank balances like current account etc.Current assets to current liabilities relationship is known as “current ratio”. Current ratio should always be greaterthan 1:1
What is the nature of working capital assets?
Working capital assets are distinct in their characteristic feature from the long-term fixed assets. Current assets turnover from one from into another and this characteristic trait of current assets is known as “turn over”. This term ismistaken to mean the value of sales or operating income in a given period. There should be no doubt in the readers’
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