Professional Documents
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Management
What is Working
Capital?
Working capital is the
capital available for
conducting the day-to-day
operations of an
organisation; normally the
excess of current assets
over current liabilities.
Working capital management is
the management of all aspects
of both current assets and
current liabilities, to minimise
the risk of insolvency while
maximising the return on assets.
The main objective of working
capital management is to get
the balance of current assets
and current liabilities right.
Importance of working capital
management
Current assets are a major financial position
statement item and especially significant to
smaller firms. Mismanagement of working
capital is therefore a common cause of
business failure, e.g.:
inability to meet bills as they fall due
demands on cash during periods of
growth being too great (overtrading)
overstocking
Working capital management is a key factor
in an organisation's long-term success.
Eg. Subiksha
The balancing act: Profitability v Liquidity
The decision regarding the level of overall investment in
working capital is a cost/benefit trade-off -liquidity versus
profitability.
Unprofitable companies can survive if they have liquidity.
Profitable companies can fail if they run out of cash to pay
their liabilities (wages, amounts due to suppliers, overdraft
interest, etc.).
Liquidity in the context of working capital management
means having enough cash or ready access to cash to meet
all payment obligations when these fall due. The main
sources of liquidity are usually:
cash in the bank
short-term investments that can be cashed in easily and
quickly
cash inflows from normal trading operations (cash sales
and payments by receivables for credit sales)
an overdraft facility or other ready source of extra
borrowing.
Cash balances and cash flows need to be monitored just as
closely as trading profits.
The working capital ratio, calculated as
current assets divided by current liabilities, is
considered a key indicator of a company's
fundamental financial health since it
indicates the company's ability to
successfully meet all of its short-term
financial obligations. Although numbers vary
by industry, a working capital ratio below 1.0
is generally indicative of a company having
trouble meeting short-term obligations,
usually due to insufficient cash flow. Working
capital ratios of 1.2 to 2.0 are considered
desirable, but a ratio higher than 2.0 may
indicate a company is not making the most
effective use of its assets to increase
revenues.
Elements of working capital
Managing working capital involves managing
the individual elements which make up
working capital:
Inventory
Debtors
Creditors
Cash
where:
CO = cost per order
D = annual demand
CH = cost of holding
one unit for one year.
2 Preparations of inventory budgets.
Organisations having huge material requirement
normally prepare purchase budgets. The purchase
budget should be prepared well in advance. The
budget for production and consumable material and
for capital and maintenance material should be
separately prepared.
Sales budget generally provide the basis for
preparation of production plans. Therefore, the first
step in the preparation of a purchase budget is the
establishment of sales budget.
There are various types of mutual funds to invest in but your best bet here
is investment in liquid funds. Liquid funds are a type of debt mutual funds
which primarily invest in money market securities as short as one day. As
the name implies, these funds have high liquidity and the returns are less
fluctuating since these funds invest in securities which are maturing in
very short-term. You can have your money back in a working days notice.
All you have to do is pop in a redemption request, and your money is
credited to your bank account.