Assessment of Working Capital Management
Introduction of Working Capital Management
When you say working capital, it is the money for everyday operations, as well as the debts that the company possesses. In this connection, this paper would like to help you to manage well your working capital, at the same time, to avoid unnecessary debts through working capital management. This is a financial tool for managing the current assets and current liabilities of any company. This is very important in order to pay regularly all the long term liabilities and daily expenses incur in the company operations. In short, working capital is the money allotted for the purchasing of raw material and it also involves sundry debtors. We all know that current assets are very important for proper working of fixed assets. Assuming that a company owner has invested a capital to purchase machines to be used in the production, it is also expected that the company has also allotted money for the purchase of raw materials, otherwise, the machines that he purchased would not be used for production because nothing can be produced without raw materials. This only shows that working capital must balance the daily operating expenses, as well as the long-term liabilities of the business in order to produce products to be sold in the market in order to gain profits. (http://www.svtuition.org/2010/02/working-capital-management.html).
Furthermore, it is also pivotal to manage properly the everyday cash flow of the business. If the business has inadequate cash in hand, then, it can be difficult for the business owner to pay for different expenses of company. As a result, the business works may delay for not paying certain expenses. From this perspective, working capital is the excess of current assets over current liabilities. There are 4 types of Working Capital as follow:
1. Gross working capital – this is a gross working capital which is used for all the current assets. In this type of working capital, the total value of current assets should be equal to gross working capital.
2. Net Working Capital – this is the net working capital is the excess of current assets over current liabilities. The equation below presents the deduction of total current liabilities from total current assets. Then, any remaining amount can still be used for the repayment of long-term loans/debts.
Permanent Working Capital – this is the amount of capital which must be in
cash or current assets for continuing the activities of business.
4. Temporary Working Capital - business owners need working capital which is more than permanent working capital, and any excess amount will be a temporary working capital of the business.
Moreover, it is important to have working capital management because it would help the company owner to estimate the need for working capital. Just the same, if the company has a great demand of finished products, therefore, it really needs to have a large amount of working capital in order to sustain the large scale production requirement. Secondly, working capital management is pivotal to manage well the return of investment. Since the low amount of working capital will increase the risk of the business.
The following are the Working Capital Policies and Guidelines that must be followed in operating a Business:
· Liquidity policy
It is very essential for finance manager to optimize the amount of liquidity for reducing the risk of business. Remember, if the company has a high amount of cash on hand and cash in bank, it will be certain that it would be able to repay its regular expenses and loans.
· Profitability policy
In this policy the finance manager must keep low amount of cash in business and try to invest maximum amount of cash and bank balance. It will only make sure that profitability of the business will boost through proper way of investments. Nonetheless, just be aware also that risk of business also increases due to the liquidity of business decreases. And, it can be a cause of bankruptcy of the business. http://www.svtuition.org/2010/02/working-capital-management.html
Another thing, it is also vital to list all the current debts and everyday expenses like mortgage, utility bills, and other daily needs of the business in order to operate successfully, such as employees’ salary, benefits, cost of advertising and marketing campaigns, annual expenses, etc. By recording the average cost of each category, the management can determine the daily cash flow of the business. Aside from that, it is best to make a total for each category, and then add all the items. Whatever the over all totals of the average annual pay out for all expenses listed, they must be divided by 365 days to get the minimum amount that a company should earn everyday to stay liquid.