Working Capital Management

WORKING CAPITAL
qCurrent assets – Current liabilities qIt measures how much in liquid assets a company has available to build its business. qA short term loan which provides money to buy earning assets. qAllows to avail of unexpected opportunities. qPositive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable and cash.

CONSTITUENTS OF WORKING CAPITAL
CURRENT ASSETS
Inventory Sundry Debtors Cash and Bank Balances Loans and advances

CURRENT LIABILITIES
Sundry creditors Short term loans Outstanding expenses 

IMPORTANCE OF WORKING CAPITAL

Arranging the sources of working capital:
It depends mainly upon the availability of funds and different application of this working capital. Current assets or working capital includes mainly three components Inventories Cash Receivables So, in short we can also say that the working capital management means to manage all these three components in the firm.

Types of Working Capital:
There are two broad classifications of the

working capital.

Gross Working Capital Net Working Capital

There are two more classifications which are also very important.
Permanent Working Capital Temporary Working Capital

Gross Working Capital:
Total Current assets Where Current assets are the assets that can

be converted into cash within year & include cash , debtors Referred as “Economics Concept” are employed to derive a rate

an accounting etc. since assets of return.

Net Working Capital:
CA – CL Referred as ‘point of view of an Accountant’. It indicates liquidity position of a firm &

suggests the extent to which working capital needs may be financed by permanent sources of funds.

Permanent Working Capital:
It refers to the amount of working capital which is

required by the firm every time. It shows the minimum level of working capital which required maintaining day to day operations of the firm.

Temporary Working Capital
It is required by the when while some changes in

production or sales volume or change in the price level of any factors of production.

 

Approaches for determining the Working Capital
There are following three types of

approaches to finance the working capital Matching Approach or Hedge Approach Conservative Approach Aggressive Approach

Matching Approach or Hedge Approach:
In this approach of financing the

working capital the firm tries to finance the permanent working capital through the long term funds and temporary working capital through short term funds. The concept behind this is that the maturity of source of funds should match the nature of assets to be financed.

Conservative Approach:
According this approach the whole

amount of working capital should be financed through the long term funds. In this approach the firm does not want to take any risk. It is a costly approach in comparison to matching approach.

Aggressive Approach:
Under this approach the firm uses the

short term funds to finance some part of permanent working capital and the whole of part of temporary working capital. But this approach is more risky for the firm, however this the cheapest approach.

Working Capital Operating Cycle
Cash Raw material Finished

Work in progress Goods Debtors Cash  

Sales Bills receivables

Demerits of Excessive Working Capital
There may be following problems It can accumulate unnecessary inventories. Thus chance of mishandling, theft, wastage of inventories may occur. It also indicates poor collection of receivable and very liberal credit policy regarding sales. The bad debts will increase it such situation continues for long time. It allows to the management to inefficiently Accumulation of excessive inventories also leads to speculative profit. This may tend to make dividend policy liberal, which may create serious problems in future. Excessive availability of cash tempts the executive to spend more.

Demerits of Inadequate Working Capital :
There may be following problemsIt becomes difficult for the firms to undertake

profitable projects due to shortage of working capital. The firm may face problems in implementing the operating plans and achieve the firm’s profit target. It also creates problem in meeting out day-to-day or routine expenses. Fixed assets can be utilized more effectively, thus the overall return may go down. Due to inadequate working capital firm may loose some good credit opportunities The firm may spoil its fame and reputation if it fails to honour short-term obligations. As a result, the firm faces tight credit terms. It directly affects the liquidity positions of the business firms.

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