importance of working capital

importance of working capital

The Importance of Working Capital Management in Avoiding Bankruptcy

Proper bookkeeping can help ensure ideal working capital management.

Managing assets and liabilities is one of the most important jobs for business managers and accountants. Small businesses in particular must strike a perfect balance between the two to successfully continue operations, because they lack the capital to absorb large losses. Proper working capital management proves essential in the avoidance of bankruptcy by helping a business balance needs with obligations. A full description of the relationship between working capital and bankruptcy requires an explanation of the relevant terminology.

Two basic definitions exist for working capital. The more technical of the two explains working capital as the difference between all short-term assets and short-term liabilities. Assets in business refer to anything of value a company owns. Liabilities are outstanding debts, such as loans and credit. The simpler definition describes working capital as the cash available for the day-to-day operations as a business. Daily operations cash comes from assets such as the sale of merchandise, and excludes money used to pay liabilities; therefore, the two definitions are essentially the same.

Working capital management entails the process of balancing the needs of short-term assets and short-term liabilities. Aspects of working capital management include short-term loans, merchandise purchased on credit, goods and services provided on credit and merchandise, goods and services paid for upon delivery. Managing working capital essentially entails managing the cash flow of a business on a daily, weekly and monthly basis in such a way that satisfies all debts while reserving enough capital to continue operations and the generation of profits.

Businesses face bankruptcy when insufficient capital resources prevents them from paying debts owed. Successful working capital management allows a business to pay all debts as they mature, or come due, while continuing profitable business operations. At the very least, successful working capital management allows a business to break even. Therefore, working capital management is directly responsible for the avoidance of bankruptcy. Unsuccessful working capital management can lead directly to bankruptcy by preventing a business from paying off liabilities or by preventing the generation of new capital with which to pay future debts.

Improving Working Capital and Management

Several methods of improving working capital and working capital management exist. Methods of improving working capital management begin with simple tasks such as monitoring expenditures and upcoming debts daily, weekly and monthly and planning in advance how to balance the two. Lowering production costs while maintaining sales revenue increases profits, thus providing more cash for working capital management. Short term working capital management problems can be solved by swapping short-term debt for long-term debt and putting money allocated for short-term debt into the generation of profits for paying off long-term debt.

Will Gish slipped into itinerancy and writing in 2005. His work can be found on various websites. He is the primary entertainment writer for "College Gentleman" magazine and contributes content to various other music and film websites. Gish has a Bachelor of Arts in art history from University of Massachusetts, Amherst.

Importance of Sufficient Working Capital

Importance of Sufficient Working Capital!

Working capital is just like a heart of the industrial enterprise. If it is weak, the business firm cannot prosper and even survive, although there is a large investment in fixed assets. Moreover not only the existence of working capital is a must for the industry, it must be adequate also.

Adequacy of working capital is the life blood and controlling nerve centre of a business unit. Similarly the volume of working capital should not be in excess than the actual requirements. “Inadequate working Capital is disastrous; whereas redundant working capital is a Criminal Waste”. Both situations are not warranted in any sound organisation.

The adequacy of working capital helps in (a) Raising credit standing of a business concern because of better terms on goods purchased, lower cost of manufacturing on account of the receipt of cash discounts, favourable rates of interest on bank loans etc. (b) A business enterprise with adequate working capital is always in a position to avail advantages of any favourable opportunity either to purchase raw materials or to execute a special order or to wait for better market position, (c) The general morale of the management of a company increases by its financial soundness, (d) During slump period the demand for working capital instead of coming down goes up. A large amount is locked up in the inventories and receivables. Companies having ample working capital can tide over the period of depression.

The principal advantages of maintaining sufficient working capital are given below:

1. Maintenance of the solvency of the company or avoidance of its commercial insolvency by continuing production.

2. Maintenance of credit by prompt payment to supplies of raw materials and others.

3. Availability of cash discount which increases the volume of profit of the company.

4. Willingness of banks to grant seasonal loans.

5. Good opportunities can be exploited, e.g., the Company may make off seasonal purchases resulting in substantial savings or it can fetch big supply orders.

6. Availability of emergency capital on soft terms is ensured.

7. Fixed assets like plant and machinery need not remain idle. This will enhance the efficiency of the assets which in turn will enhance the efficiency of the firm.

8. High morale of employees because of an environment of certainty, security and confidence which is a great psychological factor.

9. Regular payment of dividend is assured due to the availability of sufficient liquidity.

Why working capital management matters

Proper management of working capital is essential to a company’s fundamental financial health and operational success as a business. A hallmark of good business management is the ability to utilize working capital management to maintain a solid balance between growth, profitability and liquidity.

A business uses working capital in its daily operations; working capital is the difference between a business's current assets and current liabilities or debts. Working capital serves as a metric for how efficiently a company is operating and how financially stable it is in the short-term. The working capital ratio, which divides current assets by current liabilities, indicates whether a company has adequate cash flow to cover short-term debts and expenses.

The Importance of Working Capital

Working capital is a daily necessity for businesses, as they require a regular amount of cash to make routine payments, cover unexpected costs, and purchase basic materials used in the production of goods. Working capital is an easily understandable concept, as it is linked to an individual’s cost of living and, thus, can be understood in a more personal way. Individuals need to collect the money that they are owed and maintain a certain amount on a daily basis to cover day-to-day expenses, bills and other regular expenditures.

Working capital is a prevalent metric for the efficiency, liquidity and overall health of a company. It is a reflection of the results of various company activities, including revenue collection, debt management, inventory management and payments to suppliers. This is because it includes inventory, accounts payable and receivable, cash, portions of debt due within the period of a year and other short-term accounts.

The needs for working capital vary from industry to industry, and they can even vary among similar companies. This is due to several factors, including differences in collection and payment policies, the timing of asset purchases, the likelihood of a company writing off some of its past-due accounts receivable, and in some instances, capital-raising efforts a company is undertaking.

The Importance of Working Capital Management

When a company does not have enough working capital to cover its obligations, financial insolvency can result and lead to legal troubles, liquidation of assets and potential bankruptcy. Thus, it is vital to all businesses to have adequate management of working capital.

Working capital management is essentially an accounting strategy with a focus on the maintenance of a sufficient balance between a company’s current assets and liabilities. An effective working capital management system helps businesses not only cover their financial obligations but also boost their earnings.

Managing working capital means managing inventories, cash, accounts payable and accounts receivable. An efficient working capital management system often uses key performance ratios, such as the working capital ratio, the inventory turnover ratio and the collection ratio, to help identify areas that require focus in order to maintain liquidity and profitability.

Importance of Working Capital

Working capital (WC) is defined as the amount of cash that is needed for smooth and profitable business operations. Working capital is calculated as (WC= Current Assets minus (-) Current Liabilities). It is important that the working capital is maintained at positive level in order to ensure that the business runs effectively. Positive working capital helps to settle daily running expenses of the business as well as settle maturing short-range unpaid sums.

More Essay Examples on Capital Rubric

Working capital must be calculated accurately to avoid overestimations that may lead to collapse of the firm’s operations. Business operations may come to a stand still if working capital is negative. Working capital is managed through appropriate management of accounts receivable, inventories, cash and payable business amounts.

Miscalculation of working capital may result in holding up some business transactions. It may severely affect the business to a level of closing some of the branches leading to a loss of customers and incredibility of the business. Some employees may be laid off in order to cut down operating cost, while payroll preparation may be done by outsourcing if the overall cost is cheaper.

The most important thing to do in order to avoid miscalculations is to involve the management team in budget preparation since they have a wide knowledge on cash flows and receipts. Also one needs be realistic in drawing revenue forecasting so that revenue targets are set slightly lower for the trading period rather.

A business needs to operate within minimal cost. In order to rectify lack of enough working capital minimize working capital through offering discounts on cash sale hence reduce commissions paid on credit cards. Inventories may be turned within short time. Stocking high demand goods gives more returns. More so, ensuring well formulated credit rates with vendors and suppliers keeps working capital low. Business transaction records must be updated to avoid paying for wrongly delivered commodities.

In conclusion, working capital should be kept as low as possible by making more cash sales, controlling cash flows, appropriate inventory managements and manning transaction closely.

Fung, A., Hebb, T. & Roger J. (2001). Working Capital: The Power of Labor’s Pension. New

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WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES

Liquid Assets (cash and bank deposits)

Debtors and Receivables

Creditors and Payables

Other Short Term Liabilities

From a company's point of view, excess working capital means operating inefficiencies. Money that is tied up in inventory or money that customers still owe to the company cannot be used to pay off any of the company's obligations. So, if a company is not operating in the most efficient manner (slow collection), it will show up as an increase in the working capital. This can be seen by comparing the working capital from one period to another; slow collection may signal an underlying problem in the company's operations.

The objective of working capital management is to maintain the optimum balance of each of the working capital components. This includes making sure that funds are held as cash in bank deposits for as long as and in the largest amounts possible, thereby maximising the interest earned. However, such cash may more appropriately be "invested" in other assets or in reducing other liabilities.

In recent years there has been an increased focus on Dynamic Discounting as a means of optimizing Working Capital. This methods involves the early payment for goods and services bought in return for a discounted price. Operated properly, this can give a significant return on working capital.

* Ratio analysis can be used to monitor overall trends in working capital and to identify areas requiring closer management

* The individual components of working capital can be effectively managed by using various techniques and strategies

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