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Importance of Working Capital Management in financial wellbeing of a business

Working capital means current assets such as accounts receivables, inventory, prepaid expenses, cash etc. minus the current liabilities. The management of current assets is as important or rather more important that the management  of fixed assets because the fate of most of the business very largely depends upon the manner in which their working capital is managed

The study of working capital is incomplete unless we have an overall look on the management of current liabilities. Determining the appropriate level of current asset and current liabilities of level of working capital involves fundamental decisions regarding firm’s liquidity and the composition of firm’s debts.

Following are the objectives of working capital:

(a)  Maintenance of working capital at appropriate level

(b)  Availability of ample funds as and when they are needed.

In the accomplishment of these two objectives, the management has to consider the composition of current assets pool. The working capital position sets the various policies in the business with respect to general operation, purchasing financing expansion and dividend etc.

Importance of working capital management

(a)  Management of current assets: There is a positive correlation between the sale of the product of the firm and the current assets. An increase in the sale of the product requires a corresponding increase in current assets. It is therefore indispensable to manage the current assets properly and efficiently.

(b)  Management of fixed assets: More than half of the total capital of the firm is generally invested in the current assets. It simply means that half of the capital is blocked in fixed assets. We pay due attention to the management of fixed assets through the capital budgeting process. Management of working capital too therefore attracts the attention of the management.

(c)  Lease management: When the required funds are not available, fixed assets can be acquired on lease. But there is no such alternative for the current assets. Investment in current assets, which means investment in inventory, receivables etc cannot be avoided without sustaining a heavy loss.

(d)  Satisfying working capital needs: Working capital needs are more often financed through outside sources so it is necessary to utilize them in the best possible ways.

(e)  Necessary for small units: The management of working capital is more important for small units because they scarcely rely on long-term capital market and have an easy access to short-term financial sources, which is, trade credit, short-term bank loan etc.

Overall look on working capital: In the modern systems approach to management, the operations of the firm are viewed as an integrated system. In this sense, it is not possible to study one segment of the firm individually or leave it out completely. Hence an overall look on the management of working capital is necessary.


Posts by SpeakBindas Editorial Team.

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