Strongpreneur#Business Growth Strategies
January 21, 2019 399
Strongpreneur#Business Growth Strategies
January 21, 2019 399
The primary purpose of working capital management is to make sure the company always maintains sufficient cash flow to meet its short-term operating costs and short-term debt issues.
Working capital management refers to a company’s managerial accounting strategy designed to monitor and utilize the two components of working capital, current assets, and current liabilities, to ensure the most financially efficient operation of the company.
The total cost of a project consists of two distinct parts:
(a) Fixed Capital, and
(b) Working Capital.
For estimating fixed capital requirement the cost of the machinery and equipment are taken into consideration based on current quotations for each physical units from reputable companies. However, the estimation of working capital requirements is not that easy as the components of working capital involve financial flows in the current operation of the business. Because of technical specifications, while fixed capital is estimated with a high degree of accuracy, the same care and attention are often not bestowed in calculating the working capital requirements.
Definition of Working Capital
Working Capital represents the money that is required for the purchase of raw materials payment of salaries wages and other expenses and for financing the interval between the date of supply of goods and the date of receipt of payment for the same.
The term working capital may be viewed either as “gross” or “net” working capital. Networking capital represents the amount that is aimed at deducting current liabilities from current assets. Therefore, the networking capital represents the liquid surplus and forms the margin against maturing obligations of the business. For determining networking capital correctly, accurate classification of assets and liabilities into current and noncurrent assets and liabilities would be a crucial factor.
The utilization of working capital involves a cyclical process. The cycle starts with cash, purchases of raw materials which becomes work-in-progress in the next stage and finished goods in the subsequent stage. When finished goods are sold, debts are created and when collected, cash flows back into the business and again back to the stage of few materials. Then the cycle process is repeated. According to the American Institute of Certified Public Accountant (AICPA), “the average time intervening between the acquisition of materials or services entering this process and the final cash realization constitutes an operating cycle”.
The concept of operating cycle as opposed to a rule of thumb in estimating working capital is based on the tested assumption that:
Importance of Working Capital
There are several reasons why estimates of working capital should be done carefully and meticulously. A recent survey of small-scale manufacturing companies reveals that capital assets form about 70 percent of the total assets. This clearly shows what would be the serious consequences and financial embarrassment if working capital is not estimated correctly. Working capital requirements vary with the level of sales volume. It is, therefore, necessary that adequate working capital is provided in advance to meet the anticipated level of sales.
Factors Affecting Working Capital Requirements
Largely the length of the operating cycle and the rate of flow of costs determine the working capital requirements within the operating cycle. The rate of flow of a cost, in turn, depends on the volume of production and sales and the costs associated with such production or sales.
Each of these is also influenced by several factors such as the followings:
Adequacy of Working Capital
Many small businesses do not have sufficient working capital while only a few may have more than enough.
The causes of inadequate and the consequences of excess working capital are as follows.
Causes of Inadequate Working Capital
Consequences of Inadequate Working Capital
Collection Methods
Collection methods are designed to speed up the process of realizing or collecting accounts receivable in other words, they are designed to reduce the delay between the time a customer pays his bills and the time a cheque is collected and cashed to become a useful fund.
The methods include:
Disbursement Methods
Disbursement methods are aimed at paying accounts payable (liabilities) as late as possible bearing in mind the need to maintain credit standing.
Various approaches to maximizing cash disbursement float are:
The maximization of cash disbursement float has certain disadvantages, for instance, if care is not taken the creditworthiness of a firm will be affected negatively. Secondly, the use of a draft involves the payment of service charges by the firms and some suppliers may prefer cheques to drafts.
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