Competitive Exams Accountancy: Working Capital management
Working Capital Management
Working capital management is concerned with making sure we have exactly the right amount of money and lines of credit available to the business at all times. Working capital management involves the relationship between a firm's short-term assets and its short-term liabilities. The goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability 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. Working Capital is the money used to make goods and attract sales. The less Working Capital used to attract sales, the higher is likely to be the return on investment. Working Capital management is about the commercial and financial aspects of Inventory, credit, purchasing, marketing, and royalty and investment policy. The higher the profit margin, the lower is likely to be the level of Working Capital tied up in creating and selling titles the term working capital refers to the amount of capital which is readily available to an organization. That is, working capital is the difference between resources in cash or readily convertible into cash Current Assets and organizational commitments for which cash will soon be required Current Liabilities. Current Assets are resources which are in cash or will soon be converted into cash in “the ordinary course of business”
Current Liabilities are commitments which will soon require cash settlement in “the ordinary course of business”
Thus: Working Capital = Current Assets-Current Liabilities
In a department's Statement of Financial Position, these components of working capital are reported under the following headings:
Sundry creditors Working capital constitutes part of the Crown's investment in a department. Associated with this is an opportunity cost to the Crown. Money invested in one area may “cost” opportunities for investment in other areas. If a department is operating with more working capital than is necessary, this over-investment represents an unnecessary cost to the Crown. From a department's point of view, excess working capital means operating inefficiencies.
The objective of working capital management is to maintain the optimum balance of each of the working capital components. This includes making sure that funds are held as cash in bank deposits for as long as and in the largest amounts possible, thereby maximizing the interest earned. However, such cash may more appropriately be “invested” in other assets or in reducing other liabilities.
Working capital management takes place on two levels:
Ratio analysis can be used to monitor overall trends in working capital and to identify areas requiring closer management.
The individual components of working capital can be effectively managed by using various techniques and strategies. When considering these techniques and strategies, departments need to recognize that each department has a unique mix of working capital components.
The emphasis that needs to be placed on each component varies according to department. For example, some departments have significant inventory levels; others have little if any inventory. Furthermore, working capital management is not an end in itself. It is an integral part of the department's overall management. The needs of efficient working capital management must be considered in relation to other aspects of the department's financial and non-financial performance.
Liquid Assets cash and bank deposits
Debtors and Receivables
Loans & advances
Raw material and component
Creditors and Payables
Other Short Term Liabilities
Factores Influencing The Requirement Of Working Capital
1 Daily requirement of cash
2 Minimum requirement of raw material for smooth production activities
3 The number of day's requirement to convert raw material into finished product.
4 The number of day's credit given to customers