Eric Samek Brasa

What exactly is working Capital? In a business it can be explained as its current assets less its current liabilities. Current assets comprise cash, stocks of raw materials, work in progress & finished goods, marketable securities such as Treasury bills & amounts receivable from from debtors. Current liabilities comprise creditors falling due within 1 year, & may include amounts owned to trade creditors, taxation payable, dividend payments due, short-term loans, long term debts maturing within 1 year & so on.

Every business needs adequate liquid resources to keep up day to day income. It requires enough to pay for wages & salaries as they fall due & enough to pay creditors when it is to maintain its workforce & ensure its supplies. Maintaining adequate working working capital is not only important in the short term. Sufficient liquidity has to be maintained to make sure the survival of the business eventually as well. A profitable company may fail if this does not have adequate income to meet its liabilities since they fall due.

Precisely what is Working Capital Management? Make certain that sufficient liquid resources are maintained is dependent on capital management. This involves achieving a balance between the requirement to minimize the risk of insolvency and also the requirement to increase the return on assets .An excessively conservative approach resulting in high levels of cash holding will harm profits because the chance to create a return on the assets tide as cash may have been missed.

The amount of Current Assets Required. The volume of current assets required will depend on the nature of the company business. For instance, a manufacturing company may require more stocks than company in a service industry. Because the level of output by a company increases, the amount of current assets required will also increase.

Even assuming efficient stock holdings, debt collection procedures & cash management, there is certainly still a specific degree of choice in the total amount of current assets required to meet output requirement. Policies of low stock-holding levels, tight credit & minimum cash holding could be contrasted with policies of high stock (To permit for safety or buffer stocks) easier credit & sizable cash holding (For precautionary reasons).

Over-Capitalization. If there are excessive stocks debtors & cash & very few creditors there will probably an over investment from the company in current assets. It will probably be excessive & the company are usually in this respect over-capitalized. The return on the investment will be below it should be, & long-term funds is going to be unnecessarily tide up when they may be invested elsewhere to generate income.

Over capitalization regarding working capital should never exist if there is good management nevertheless the warning since excessive working capital is poor accounting ratios. The ratios which can aid in judging if the investment linrmw working capital is reasonable range from the following.

Sales /working capital. The volume of sales as being a multiple from the working capital investment should indicate weather, in comparison with previous year or with a similar companies, the complete worth of working capital is simply too high.

Liquidity ratios. A current ratio in excess of 2:1 or even a quick ratio greater than 1:1 might point to over-investment in working capital. Turnover periods. Excessive turnover periods for stocks & debtors, or perhaps a short time of credit taken from supplies, might indicate that the level of stocks of debtors is unnecessarily high or perhaps the volume of creditors too low.

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