1. Working Capital Management - Meaning and Significance:
Working capital is the amount of financing required to sustain optimal balances of the
firm's working capital assets. Working capital represents that portion of capital which
circulates from one form to another in the ordinary conduct of business. This idea
embraces the recurring transition from cash to inventories to receivable to cash that forms
the conventional chain of business operations. Working assets are those assets that will
turnover or release cash within a relatively short period of time; they include inventory,
accounts receivable, liquid assets etc. It is therefore the investment in short-term or current
assets. Current assets are limited by accounting convention to those assets that are
expected to be converted into cash within a year. A portion of the current assets is financed
by current liabilities i.e. Sundry creditors, bills payable, outstanding liabilities, etc. Current
liabilities are defined as those obligations which are due within one year. As cash
substitutes, marketable securities may be considered as part of working capital; similarly,
the inclusion of prepaid expenses may be justified because they represent services owed to
the company that are used in carrying out its activities, thereby obviating the need for cash
outlays. Thus working capital is composed of cash investments in which surplus finds are
temporarily placed, receivable, inventories and certain period item; net working capital is
the difference between this amount and short term liabilities, such as accounts payable,
bills payable, income tax payable and other obligations currently due. Gross working
capital is the total of the current assets. Net working capital is the current assets less
current liabilities. In other words, net working capital is that portion of the current assets
financed by long-term debt and equity sources. The concept of working capital is built on
these important elements:
(a) Financing working capital assets i.e. Current assets.
(b) The amount of cash tied up in working assets.
(c) The speed with which these assets are converted into cash.
Working capital management is essentially a cash flow management. It involves managing
the cash flows associated with each of the major components. When unnecessary working
capital balances are avoided, the movement of money flow through the various
components of working capital components is accelerated and a firm's cash flows and
profitability scores improvement.
Working capital management encompasses the administration and control of current
assets, utilisation of short-term financing via various current liability sources and control of
the amount of networking capital.