WORKING CAPITAL
INTRODUCTION
Financial Management is that managerial activity which is concerned with the
planning and controlling of the firm’s financial resources.
Financial management focuses on finance manager performing the various tasks as
Budgeting, Financial Forecasting, Cash Management, Credit Administration,
Investment Analysis, Funds Management, which help in the process of
decision making.
Financial management includes management of assets and liabilities in the long run
and the short run.
The management of fixed and current assets, however, differs in three important
ways: Firstly, in managing fixed assets, time is very important; consequently
discounting and compounding aspects of time element play an important r o l e i n
capital budgeting and a minor one in the management of current
a s s e t s . Secondly, the large holdings of current assets, especially cash,
strengthen firm’s liquidity position but it also reduces its overall profitability. Thirdly,
the level of fixed as well as current assets depends upon the expected sales,
but it is only the current assets, which can be adjusted with sales fluctuation in
the short run.
Here, we will be focusing mainly on management of current assets and current
liabilities. Management of current assets needs to seek an answer to the
following question:
Why should you invest in current assets?
How much should be invested in each type of current assets?
What sources of funds should be used to finance current assets?
What should be the proportion of short-term and long-term funds to finance the
current assets?
CONCEPT OF WORKING CAPITAL
Working Capital Management is the process of planning and controlling the level and
mix of current assets of the firm as well as financing these assets. Specifically,
Working Capital Management requires financial managers to decide what
quantities of cash, other liquid assets, accounts receivables and inventories the firm
will hold at any point of time.
Working capital is the capital you require for the working i.e. functioning of
your business in the short run.
Gross working capital Refers to the firm’s investment in the current assets and
include cash, short-term securities, debtors, bill receivables and inventories.
It is necessary to concentrate on the fact that the investment in the current assets
should be neither excessive nor inadequate.
Working Capital requirement of a firm keeps changing with the change in the
business activity and hence the firm must be in a position to strike a balance
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WORKING CAPITAL
between them. The financial manager should know where to source the funds from,
in case the need arise and where to invest in case of excess funds.
The dangers of excessive working capital are as follows:
It results in unnecessary accumulation of inventories. Thus the chances of
inventory mishandling, waste, theft, and losses increase.
It is an indication effective credit policy and slack collection period. Consequently
higher incidence of bad debts occur which adversely affects the profits.
It makes the management complacent which degenerates into managerial
efficiency.
Tendencies of accumulating inventories to make speculative profits grow. This
may tend to make the dividend policy liberal and difficult to copes within future
when the firm is unable to make speculative profits.
The dangers of inadequate working capital are as follows:
It stagnates growth. It becomes difficult for the firms to undertake profitable
projects for non-availability of the working capital funds.
It becomes difficult to implement operating plans and achieve the firms profit
targets.
Operating inefficiencies creep in when it becomes difficult even to meet day-to-
day commitments
Fixed assets are not efficiently utilized. Thus the rate of return on investment
slumps.
It renders the firm unable to avail attractive credit opportunities etc.
The firm loses its reputation when it is not in position to honor its short-term
obligations. As a result the firm faces a tight credit terms.
Net working capital
