>> February 22, 2010
Introduction of Working Capital Management
Working capital management is the device of finance. It is related to manage of current assets and current liabilities. After learning working capital management, commerce students can use this tool for fund flow analysis. Working capital is very significant for paying day to day expenses and long term liabilities.
Meaning and Concept of Working Capital and its management
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.
In working capital management, we analyze following three points
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.
1st Working capital policy
Under this policy, finance manager will increase the amount of liquidity for reducing the risk of business. If business has high volume of cash and bank balance, then business can easily pays his dues at maturity. But finance manger should not forget that the excess cash will not produce and earning and return on investment will decrease. So liquidity policy should be optimized.
2nd Working Capital Policy
Under this policy, finance manger will keep low amount of cash in business and try to invest maximum amount of cash and bank balance. It will sure that profit of business will increase due to increasing of investment in proper way but risk of business will also increase because liquidity of business will decrease and it can create bankruptcy position of business. So, profitability policy should make after seeing liquidity policy and after this both policies will helpful for proper management of working capital.
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