What Does Working Capital Management Manage (2023)

FAQs

What Does Working Capital Management Manage? ›

Working capital management requires monitoring a company's assets and liabilities to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations. Managing working capital primarily revolves around managing accounts receivable, accounts payable, inventory, and cash.

Working capital management is the process of managing current assets and liabilities to ensure the short-term liquidity of your firm.

In simpler terms, it's all about efficiently managing the day-to-day cash flow of a business to ensure smooth operations and maintain financial health. Working capital management includes managing inventory, accounts receivable, accounts payable, and other short-term financial obligations.

Working Capital Management in a Nutshell

A well-run firm manages its short-term debt and current and future operational expenses through its management of working capital, the components of which are inventories, accounts receivable, accounts payable, and cash.

A company's working capital is made up of its current assets minus its current liabilities. The primary objective of working capital management is to ensure a smooth operating cycle of the business. Secondary objectives are to optimize the level of working capital and minimize the cost of such funds.

Working capital management involves balancing movements related to five main items – cash, trade receivables, trade payables, short-term financing, and inventory – to make sure a business possesses adequate resources to operate efficiently.

What is an example of working capital management? An example of working capital management is computing the Accounts Receivable Turnover Ratio and then computing the day's sales in receivables. Another example is analyzing the change in the working capital ratio from one year to the next.

The two major components of Working Capital are Current Assets and Current Liabilities. One of the major aspects of an effective working capital management is to have regular analysis of the company's currents assets and liabilities.

Major components of working capital are its current assets and current liabilities, and the difference between them makes up the working capital of a business. Current assets comprise trade receivables, inventory, and cash & bank balances, and current liabilities majorly comprise trade payables.

What are the two main objectives of working capital management 4 marks? ›

(b) The two main objectives of working capital management are to ensure profitability (generating return for investors) while at the same time ensuring liquidity (meeting its obligations when they fall due).

The key principles of working capital

One principle is to maintain a balance between current assets, such as cash, accounts receivable, and inventory, with current liabilities like accounts payable and short-term loans. Another principle is efficient inventory management.

Capital structure can be a mixture of a company's long-term debt, short-term debt, common stock, and preferred stock.

Cash and cash equivalents—including cash, such as funds in checking or savings accounts, while cash equivalents are highly-liquid assets, such as money-market funds and Treasury bills. Marketable securities—such as stocks, mutual fund shares, and some types of bonds.

Long-term working capital sources include long-term loans, provision for depreciation, retained profits, debentures, and share capital. Short-term working capital sources include dividend or tax provisions, cash credit, public deposits, and others.

The net income approach, static trade-off theory, and the pecking order theory are three financial principles that help a company choose its capital structure. Each plays a role in the decision-making process depending on the type of capital structure the company wishes to achieve.