Working Capital Management

Modes of Short-Term Working Capital Financing

The excess of the amount of working capital over permanent working capital is known as variable or short-term working capital. The amount of such working capital keeps on fluctuating from time to time on the basis of business activities. It may again be sub-divided into seasonal and special working capital. Seasonal working capital is required to meet the seasonal demands of busy periods occurring at stated intervals. On the other hand, special working capital is required to meet extra-ordinary needs for contingencies.

The main sources of short-term working capital are as follows:

1. Indigenous Bankers

Private moneylenders and other country bankers used to be the only source of finance prior to the establishment of commercial banks.… Read the rest

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Modes of Long-Term Working Capital Financing

Working capital refers to that part of the total capital employed which has been invested for the financing of current assets e.g. inventories, debtors, cash and bank balances, bills receivable, prepaid expenses etc. That is, total of all current assets is working capital.

Firms need both a long-term (or permanent) investment in working  capital and a short-term or cyclical one. The permanent working capital  investment provides an ongoing positive net working capital position, that is,  a level of current assets that exceeds current liabilities. This allows the firm to  operate with a comfortable financial margin since short-term assets exceed  short-term obligations and minimizes the risk of being unable to pay its
employees, vendors, lenders, or the government (for taxes).… Read the rest

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Impact of Inflation on Working Capital Requirement

The term inflation refers to rise in general (on an average basis) price level of goods and services in the economy, i.e., fall in purchasing power of money. Working Capital is the money used to make goods and attract sales. During the period of rising prices, a firm needs more funds to finance working capital. Hence, it should be planned properly. Not under-standing the impact of inflation on working capital has been the cause of many business failures. Cost of financing the working capital rises because of increase in interest rates. Cash should never be allowed to remain idle (Time eats value of money, i.e.,… Read the rest

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Inefficient Working Capital Management

Working capital management is an important component of management of corporate finance; since it directly influences firm’s profitability as well as liquidity in everyday activities. In any business organization, it is obvious that there must be sufficient working capital to run day to day operation. Therefore, to operate the business activities smoothly, working capital of firm’s must be sufficient. Then, the concern of working capital management is setting sufficient (optimal level) of working capital and managing short term assets and liabilities of firms within a specified period of time, usually one year. It is obvious that, the importance of efficient working capital management is unquestionable to all business activities.… Read the rest

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Estimation of Working Capital Requirements

In estimating working capital needs, different people adopt different approaches. Some experts suggest that the working capital should be greater than the minimum requirements of the firm. The management should feel safety. It would be able to meet its obligations even in adverse circumstances. However, the excessive capital may lead to waste and inefficiency. On the other hand, some experts suggest that the working capital should be lower than the requirement so that no idle funds shall be invested in the current assets and it ultimately leads to increase in profitability of the company. However, in such case the firm always have risk of technical insolvency as it may not meet its obligations as and when they falls due for payment.… Read the rest

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Determinants of Working Capital

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.… Read the rest

Abey Francis