Working capital Questions

1. Prepared by: MuhammadArmanYousaf
1- Justify the role of finance manager in balancing the balance sheet?
The vital role of financial managers is to ensure the financial health of an organization through
investment activities and long-term financing strategies. FMs perform data analysis and advise
senior managers on profit-maximizing ideas.
Financial Manager is not the only responsible person to ensure maximizing the profitability but
there are other resources exist in a large/Medium size companies that contribute from their end
like financial controllers, treasurers, credit managers, cash managers, risk managers and
insurance managers etc & their ultimate objective is to maximize long term return to the equity
holders.
Role of Financial Manager at a Glance
Financial manager perform data analysis and advise senior managers on profit-maximizing ideas.
In order to ensure balance sheet healthy & to keep it intact/balancing, FMs are dutiful to make
the Balance sheet total items accurate that include Long term & short term Assets & Liabilities,
but since we’ve considerably taught about Working capital management, therefore, I’ll here
discuss the role of Finance manager majorly exist in balancing the balance sheet with respect to
Working capital.
Financial managers are primarily responsible to be watchful at the working capital items that
include operating items like Cash flow management, ARs, Payables, Current Assets, and Current
Liabilities etc.
The more working capital a firm has on hand, the less financial strain a company experiences.
Here’s the easiest calculation of Working Capital:
Current Assets - Current Liabilities = Working Capital
This is primarily in order to attract potential & serious Investors, Finance Manager has to pay a
substantial role to keep his balance sheet intact with respect to working capital, hence, the
balance sheet could appeal the investors with respect to company financial position. The
criticality of Working capital in the balance sheet quite important since it explicitly reveals the
financial condition of a business than almost any other calculation because it tells what would be
left if a company took all of its short-term resources, and used them to pay off its short-term
liabilities. So the role of Financial Manager here is to keep moving with balancing the working
capital items & to use his/her tactical skills where needed.
One of the main advantages of looking at the working capital position is being able to foresee
any financial difficulties that may arise. Even a business that has billions of dollars in fixed assets

2. Prepared by: MuhammadArmanYousaf
will quickly find itself in bankruptcy court if it can't pay its monthly bills. Under the best
circumstances, poor working capital leads to financial pressure on a company, increased
borrowing, and late payments to creditor - all of which result in a lower credit rating. A lower
credit rating means banks charge a higher interest rate, which can cost a corporation a lot of
money over time.
For instance, in order to smoothly run the cash flow of the business, ARs is the most important
item, thus, policies & strategies being made by the Financial Manager by keeping other
stakeholders in decision/loop to speed up ARs recovery & to minimize the credit days. On the
similar lines, the relaxation for APs, if there are cash outflow constraints in the organization.
2- What are the types of working capital polices and discuss the advantages and disadvantages
of these types?
A company needs to closely monitor its working capital levels in order to keep its cash
requirements firmly in check. Lack of attention to the investment in working capital (which is
receivables,inventory, and payables)can result in a runaway need for cash,especiallywhen sales
are growing. A business can do this most effectively by instituting and enforcing a number of
policies. The following working capital policies are sorted by the component of working capital
that they most directly affect.
Three Types of Working Capital Policies
It is constructed on the approach of the finance manager towards risk, profitability and liquidity,
the working capital policies can be divided into following three types.
Restricted Policy
In restricted policy, the estimation of current assets for achieving targeted revenue is done very
aggressively without considering for any contingencies and provisions for any unforeseen event.
After deciding, these policies are forcefully implemented in the organization without tolerating
any deviations.
Advantage & Disadvantage of Restricted Policy: Adopting this policy would result into an
advantage of lower working capital requirement due to lower level of current assets. This saves
the interest cost to the company and which in turn produces higher profitability i.e.higher return

3. Prepared by: MuhammadArmanYousaf
on investment (ROI). On the other hand, there is disadvantagein the form of high riskdue to very
aggressive policy. That is why; it is also called as aggressive working capital policy.
Relaxed Policy
Relaxed policy is just the opposite of restricted policy. In this policy, the estimation of current
assets for achieving the targeted revenue is prepared after careful consideration of uncertain
events such as seasonal fluctuations, sudden change in level of activities or sales etc. After the
reasonable estimates also, a cushion to avoid any unforeseen circumstances is left to avoid the
maximum possible risk.
Advantage&Disadvantageof Relaxed Policy: The companies having relaxed working capital policies
assume an advantage of almost no risk or low risk. This policy guarantees the entrepreneur of
the smooth functioning of the operating cycle. We know that earnings are more important than
higher earnings. On the other hand, there is a disadvantage of lower return on investment
because higher investment in the current assets attracts higher interest cost which in turn
reduces profitability. Because of its conservative nature, this policy is also called as conservative
working capital policy.
Moderate Policy
Moderate policy is a balance between the two policies i.e. restricted and relaxed. It assumes
characteristics of the both the policies. To strike a balance, moderate policy assumes risk which
is lower than restricted and higher than conservative. In profitability front also, it lies between
the two.
Advantage & Disadvantage of Moderate Policy: The biggest benefit of this policy is that it has
reasonable assurance of smooth operation of working operating capital cycle with moderate
profitability.
Working capital policies can be further framed for each component of net working capital i.e.
cash, accounts receivable, inventory and accounts payable. Cash policies can be to maintain
appropriate level of cash. When level is high, it should be invested in liquid investments for short
term and vice versa. Accounts receivable policy may state about payment terms, credit period,
credit limit, etc. Inventory policy may speak of minimizing the levels of inventory till the point it
pose any risk to satisfaction of customer demands. Accounts payable policies include policies of
payment terms, quality terms, return policies, etc.