Working capital management, defined as current assets minus current liabilities, is a business technique that assists businesses in making optimal use of current assets while maintaining sufficient cash flow to satisfy short-term goals and responsibilities. Companies may free up cash that might otherwise be locked up on their balance sheets by successfully managing working capital. As a consequence, they may be able to minimize their reliance on external borrowing, expand their operations, fund mergers and acquisitions, or engage in research and development.
If you are a corporate finance student and need corporate finance homework help then you can contact us anytime.
Objectives of working capital management
- Working capital is an important measure for organizations to monitor since it indicates the amount of money available to make payments, cover unexpected expenditures, and ensure business operations continue as usual. However, working capital management is not so easy, and a working capital management programme may have numerous aims, such as:
- Working capital management should always guarantee that the company has enough liquidity to satisfy its short-term obligations, which can be accomplished by collecting payments from consumers sooner or extending supplier payment terms. Unexpected costs might also be considered obligations, so they must be integrated into the working capital management strategy.
- With that stated, it's equally critical to make good use of your short-term assets, whether that means supporting worldwide expansion or investing in R & D. If your company's assets are encumbered by inventory or accounts payable, it may not be as profitable as it could be. In other words, an overly cautious approach to working capital management is ineffective.
- Another goal of working capital management is to maximize the efficiency of capital utilization, whether by lowering capital expenses or increasing capital returns. The first may be accomplished by recovering money that is now locked up in order to decrease the requirement for borrowing, whilst the latter includes ensuring that the ROI of excess capital exceeds the average cost of financing it.
Effective working capital management
Accelerating the CCC can enhance a company's working capital situation, but it may have unintended repercussions. Reduced inventory levels, for example, may have a detrimental influence on your capacity to fulfill orders.
In the case of DPO, your accounts payable are also your suppliers' accounts receivable; therefore, if you pay suppliers later, you may be enhancing your own working capital at the expense of your suppliers' working capital. This might harm your relationships with suppliers and make it harder for cash-strapped providers to fulfill your orders on schedule.
Therefore, effective working capital management is taking actions to enhance the company's working capital situation while avoiding negative effects elsewhere in your supply chain. This might involve lowering DSO by implementing more efficient invoicing systems, allowing clients to receive bills sooner. Alternatively, it might imply implementing an early payment scheme that allows your suppliers to get money sooner than they would otherwise.
Conclusion
Working capital management is a business approach that ensures a firm works efficiently by monitoring and maximizing the use of its current assets and liabilities. Working capital management efficiency may be measured using ratio analysis.
0
