Financial Management

There are no set rules or formulate to determine the working capital requirements of a firm. The corporate management has to consider the various factors in making decisions regarding working capital balances. An appraisal of these would provide guidance to management in estimating prospective needs. These are called as determinants of working capital. The firm must estimate its working capital very accurately because excessive working capital results in unnecessary accumulation of inventory and wastage of capital whereas shortage of working capital affects the smooth flow of operating cycle and business fails to meet its commitment. In this section let us examine the various  determinants of working capital. Nature of Business is one of the factors. Usually in trading businesses the working capital needs are higher as most of their investment is found concentrated in stock. On the other hand, manufacturing/processing business need a relatively lower compared to that of trading Continue reading

Working capital management is concerned with the problem that arises in attempting to manage the current assets, the current liabilities and the inter-relationship that exist between them. The goal of working capital management is to manage a firm’s current assets and current liabilities in such a way that a satisfactory level of working capital is maintained. The financial manager must keep in mind the following principles of working capital management: Principle of Optimization:The level of working capital must be so kept that the rate of return on investment is optimized. In other words, the working capital should be maintained at an optimum level. This is the point at which the increase in cost due to decline in working capital is equal to the increase in the gain associated with it. According to the principle of optimization, the magnitude of working capital should be such that each rupee invested adds to Continue reading

Having dealt with the size of investment in current assets, the methods of financing of working capital needs our attention. Working capital is financed both internally and externally through long-term and short-term funds, through debt and ownership funds. In financing working capital, the maturity pattern of sources of finance depended much coincide with credit period of sales for better liquidity. Generally, it is believed that funds for acquiring the fixed assets should be raised from long term sources and short-term sources should be utilized for raising working capital. But in the recent modern enterprises, both the types of sources are utilized for financing both fixed and current assets. There are basically three approaches to financing working capital. These are: the Hedging approach, the Conservative approach and the Aggressive approach. Hedging Approach:  The hedging approach is also known as the matching approach. Under this approach, the funds for acquiring fixed assets Continue reading

Investment in working capital involves determination of the total quantum of current assets, the size of individual items of current assets and the operating cycle. These may be planned, adopting any of the following approaches, viz. industry norm approach, economic mode approach and strategic choice approach. Under the Industry norm approach the size and composition of current assets are determined according to the convention or norms adopted by die firms in the industry. For instance, 2 months production requirements of raw materials, 1 months production needs of work-in-process, 3 months sales of finished stock, 2 months credit to customers, etc. may be norms and you follow the norms. When this approach is adopted, automatically total volume arid component size of currents assets become proportional with level of activity. But this approach is not scientific. It is a rule of thumb. But we cannot say it is a wrong course. Under Continue reading