Investment in Working Capital

Investment in working capital means to invest money in liquid and current assets. We all know that working capital is important, if we want to operate our fixed assets more efficiently. Like investment in fixed capital decision, investment in working capital decision is also important. In working capital investment, we keep our some money in cash. We also invest our some money in the form of inventory, debtors and short term securities. Value of these investment must be more than our current liabilities.

Now, important question is, "How much excess amount should be invested?" Our current assets are $ 10000 and our current liabilities are $ 7000. Our investment in working capital is $ 3000. Now, question is, whether $ 3000 investment is sufficient or not.

To know this answer, we have to study many factors which affect our investment in working capital.

{Important Note: We are studying these factors because we are interested to optimum investment in working capital. If we invested over money in working capital, it will not generate profit and our profit will decrease. If we invested under money in working capital, it will increase the risk of our solvency. Suppose, we have no money to pay our creditor on the time due to under working capital investment. It means, he has to challenge our solvency.}

1. Inventory Cycle 

We need investment of working capital for buying raw material. We have to calculate inventory conversion period. It will tell us when our inventory cycle will complete. According to this, we think to invest our money in working capital.

2. Creditor Conversion Period

We have to save some money for paying our creditors. Both long term and short term creditors' payment is from cash. Our creditor conversion period will explain when we have to pay them next.

4. Debtor Conversion Period

We also expect that our debtor will give our money after some time but when they will give our money. Up to that time, we need to invest money in debtors, after completing debtor conversion period, we need not to invest money in debtors. Suppose, our debtor will pay after 60 days. It means only for 60 days, we need money to buy goods and paying other expenses. But after 60 days, we will get money from debtors, it means no need to invest extra amount in cash because same cash we will get from debtors.

5. Unexpected Expenses 

Some expenses, we do not expect due to uncertainty. Suppose, our employee is doing our company's duty and in the market, if he faces accident and he has no money for treatment, it is the duty of company to pay his treatment bill. But company is not NGO which will help. But taking it as social responsibility, company can pay in the form of loan to employee. But for this, company has to take decision to invest his working capital for such unexpected expenses.

6. Our Approaches

Some company invest in working capital on approaches basis. For example, according to matching approach, company will invest long term finance in long term fixed assets and short term finance in short term current assets. But its opposite is conservative approach in which company invest his long term finances in long term fixed assets and also in short term current assets.

Related : Financial Management