Working Capital Management: Introdution

Any firm, from time to time, employs its short-term assets as well as short-term financing sources to carry out its day to day business. It is this management of such assets as well as liabilities which is described as working capital management. Working capital management is a quintessential part of financial management as a subject. It can also be compared with long-term decision-making the process as both of the domains deal with the analysis of risk and profitability.

Working capital is the Life blood of any business unit. Working capital means that capital which enables the working (operations of the organization) Working capital is required for the initial as well as regular operations. Its effective management can do much more to the success of the business and vice-versa. Among the most important items of working capital are Levels of inventory, accounts receivable, and accounts payable. Analysts look at these items for signs of a company's efficiency and financial strength. Thus, the working capital management comprises the management of all these components, individually and collectively too.
Working capital is formally arrived at by subtracting the current liabilities from current assets of a firm on the day the balance sheet is drawn up. Working capital is also represented by a firm’s net investment in current assets necessary to support its everyday business. Working capital frequently changes its form and is sometimes also referred to as circulating capital.

“circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another.” - Gretsenberg

Working capital management is a business strategy designed to ensure that a company operates efficiently by monitoring and using its current assets and liabilities to the best effect. The primary purpose of working capital management is to enable the company to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations.
In the present scenario of cutthroat competition, the business does not have any other option then cutting the cost of its operations, for this effective management of working capital forms an important part of cost reduction. As it is evidenced by many researches, in any manufacturing unit, the proportion of raw material in the total cost of the product will be the highest and hence if the organization wants to minimize the cost of production it has to tackle the cost of raw material first. If it is interested in improving its Liquidity, it increases the Level of its working capital. However, this policy is Likely to result in a reduction of the sales volume, therefore of profitability. Hence, a company should strike a balance between Liquidity and profitability.

A firm is required to maintain a balance between Liquidity and profitability while conducting its day to day operations. Liquidity is a precondition to ensure that firms are able to meet its short-term obligations and its continued flow can be guaranteed from a profitable venture. The importance of cash as an indicator of continuing financial health should not be surprising in view of its crucial role within the business. This requires that business must be run both efficiently and profitably. In the process, an asset-Liability mismatch may occur which may increase firm’s profitability in the short run but at a risk of its insolvency. On the other hand, too much focus on Liquidity will be at the expense of profitability and it is common to find finance textbooks (for e.g see Gitman, 1984 and Bhattacharya, 2001) begin their working capital sections with a discussion of the risk and return tradeoffs inherent in alternative working capital policies. Thus, the manager of a business entity is in a dilemma of achieving desired tradeoff between Liquidity and profitability in order to maximize the value of a firm.

Working capital was defined as the money tied up in inventory and receivables less payable. For most product based businesses, the amount of money tied up in working capital can be substantial. If it could reduce its inventory and receivables, it could eliminate some of its debt and related interest costs. The focus is to Looks at ways of managing working capital at an optimum Level, using techniques for reducing the amount of inventory that is held, speeding up the collection of receivables and deferring the settlement of payables.