What is meant by working capital management? What factors would you like to take into consideration in estimating the working capital requirement of a concern? Discuss the repercussions if a firm has inadequate working capital.

ANSWER: Working capital is that part of company’s capital which is used for purchasing raw material and involve in sundry debtors. We all know that current assets are very important for proper working of fixed assets. Suppose, if you have invested your money to purchase machines of company and if you have not any more money to buy raw material, then your machinery will no use for any production without raw material. From this example, you can understand that working capital is very useful for operating any business organization. We can also take one more liquid item of current assets that is cash. If you have not cash in hand, then you can not pay for different expenses of company, and at that time, your many business works may delay for not paying certain expenses. If we define working capital in very simple form, then we can say that working capital is the excess of current assets over current liabilities.

Types of Working Capital:                             

1. Gross working capital:

            Total or gross working capital is that working capital which is used for all the current assets. Total value of current assets will equal to gross working capital.

2. Net Working Capital:

            Net working capital is the excess of current assets over current liabilities.

Net Working Capital = Total Current Assets – Total Current Liabilities

This amount shows that if we deduct total current liabilities from total current assets, then balance amount can be used for repayment of long term debts at any time.

3. Permanent Working Capital:

            Permanent working capital is that amount of capital which must be in cash or current assets for continuing the activities of business.

4. Temporary Working Capital 

            Sometime, it may possible that we have to pay fixed liabilities, at that time we need working capital which is more than permanent working capital, then this excess amount will be temporary working capital. In normal working of business, we don’t need such capital.

FACTORS THAT TAKEN INTO CONSIDERATION BEFORE ESTIMATING WORKING CAPITAL

What is the need for working capital?                    

            After study the nature of production, we can estimate the need for working capital. If company produces products at large scale and continues producing goods, then company needs high amount of working capital.

What is optimum level of Working capital in business?       

            Have you achieved the optimum level of working capital which has invested in current assets? Because high amount of working capital will decrease the return on investment and low amount of working capital will increase the risk of business. So, it is very important decision to get optimum level of working capital where both profitability and risk will be balanced. For achieving optimum level of working capital, finance manager should also study the factors which affects the requirement of working capital and different elements of current assets. If he will manage cash, debtor and inventory, then working capital will automatically optimize.

What are main Working capital policies of businesses?             

            Policies are the guidelines which are helpful to direct business. Finance manager can also make working capital policies.

The Repercussions if a firm has inadequate working capital

1. The firm is unable to take advantages of new opportunities or adapt to change.    

2. Trade discounts are lost. A firm with sufficient working capital is able to finance larger stocks and can therefore place large orders.    

3. Cash discounts are lost. Some firms will try to persuade their debtors to pay early by offering cash discounts.     

4. The advantages of being able to offer a credit line to customers are forgone.    

5. Financial reputation is lost due to non-payment of trade creditors on time.   

6. Creditors may apply to the court for winding up if the firm fails to pay their obligations on time.