The Working Capital Management of a Company (Concepts, Types and Factors)!
It is a well known fact that current assets are very important for proper working of fixed assets. Merely buying best of machines for the company but not having money to buy raw material and different expenses, the best of machines will serve no purpose.
Working capital is very significant for paying day to day expenses and long term liabilities.
Concept of Working Capital and its management:
In its simplest form working capital represents the excess of current assets over current liabilities. Working capital management decisions involve managing relationship between a firm’s short-term assets, i.e., current assets and its short-term liabilities, i.e., current liabilities. The objective is to ensure that firm’s operations continue unhindered and that it has sufficient cash flow to meet both maturing short-term debt and upcoming operational expenses.
Working capital management entails short term decisions. Short-term decisions mean decisions relating to the next one year period. These decisions are not taken the way capital investment decisions are made. These decisions are based on cash flows and/or profitability (Return on capital). In brief, working capital management involves following three things:
(i) Determining the need for working capital (cash, inventory, debtors, and short-term financing) (ii) Determining optimum (neither under nor over) level of working capital; and (iii) Determining working capital policies (Liquidity and profitability).
Types of Working Capital:
1. Gross working Capital:
Total or gross working capital represents to the 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 represents the excess of current assets over current liabilities (net working capital Total current assets (-) Total liabilities). It also shows that the money, left after deducting total current liabilities from total current assets, can be used for repayment of long term debts.
3. Permanent Working Capital:
Permanent working capital represents that part of capital which must be in cash or current assets for continuing the activities of business.
4. Temporary Working Capital:
At times, it may become necessary to pay fixed liabilities. At that time we need working capital which has to be more than permanent working capital. This excess amount will be called temporary working capital. In normal working of business, we don’t need such capital.
Factors affecting Working Capital Requirements:
Following factors affect the quantum of working capital:
a. Nature of business:
Firms engaged in trading companies require less working capital. But manufacturing companies have a greater requirement compared with trading companies or retail shops because the transactions are mostly done in cash, length of the operating cycle is small, time gap between goods acquired and sold is less; and turnover is high.
b. Period of credit availability:
Less working capital is required if suppliers offer a liberal credit policy.
c. Tenure of manufacturing cycle:
If time taken to convert raw material to finished goods is long then more working capital is required and vice versa.
d. Quantum of inventory required:
If the business is required to maintain a large stock of inventory then working capital requirement will be greater and vice versa.
e. Seasonal operations:
Companies having a steady demand for their products in the market throughout the year, the working capital requirements remain constant throughout the year. However, if the demand is seasonal, then to cater to this increase in sales, more has to be produced. During that time more working capital is required.