Meaning of Working Capital Management
Working capital management is a process of managing the working capital requirements of the organisation for running smoothly. Working capital is simply the cash required for meeting daily expenses and for operation of day to day activities. Working capital management involves the management of current assets and current liabilities to ensure optimum liquidity in business for its proper functioning. It mainly focuses on always maintaining sufficient cash in an organisation to easily meet its short-term debts and operating expenses.
Management of working capital is not only concerned with maintaining proper liquidity in business but also with Working capital financing. It aims at economical procurement of working capital required and efficient utilisation of that capital to derive better results. Working capital management performs ratio analysis of operating expenses key elements: Inventory turnover ratio, working capital ratio and collection ratio. It aims at maintaining these three ratios at an optimum level which helps in the smooth functioning of the business.
Ratio between current assets and current liabilities depicts the liquidity and short-term financial health of the company. Management of working capital ensures that there is an optimum investment in current assets because the excessive and inadequate investment will have adverse effects. It will hamper productivity and solvency of the organisation. Most ideal ratio between current assets and current liabilities should be between 1.2 and 2. Importance of working capital management is discussed as given below:
Importance of Working Capital Management
Improves liquidity and Solvency Position
Working capital management helps in increasing the liquidity and solvency position of business. Proper management of work capital enables timely payment of all short term debts as well as various operating expenses. It ensures adequate investment of business capital in assets maintaining a proper ratio between current asset and current liabilities. This improves their cash management and maintains proper liquidity of funds in business so that they are less dependent on external financing.
Ensures Uninterrupted Business Operations
Management of working capital ensures continuous and smooth functioning of business operation. It aims at maintaining an adequate amount of funds at every point of time in business. Business is getting their raw materials regularly by timely paying their supplier. Timely payment of employees’ wages and salaries will motivate them to work regularly and also the business is able to meet their daily operating expenses timely with sufficient availability of funds. All this will lead to uninterrupted operations of business.
Increase Profitability and Productivity
Working capital management improves the efficiency of organisations. It focuses on improving productivity and profitability. Management of working capital helps in managing the account payables and account receivables of the business. It helps in procuring required capital economically and utilising it efficiently. This enables increasing the profitability of the organisations.
Maintenance of adequate working capital helps business in improving its goodwill. Businesses with the sound working capital position are able to make timely and prompt payments of all their outstanding bills. They are able to pay all their short term liabilities and operating expenses timely. Timely payment of all expenses helps in enhancing the reputation of the business.
Better working capital position increase the creditworthiness of organisations. Such organisation enjoys better solvency and good credit rating. They are easily able to raise funds from banks and financial institutions as per favourable terms. It helps them in meeting all their additional capital requirements in case of expansion and diversification plans.
Timely Payment of Dividends
Proper management of working capital helps in paying regularly return to shareholders. Availability of sufficient funds helps the organisation in timely and orderly payment of dividends. It helps in gaining the confidence of shareholder and makes them happy. Shareholders also support them by providing them funds as and when required.
Helps in Facing Contingencies
Every business faces certain contingencies in its course of operations. Maintenance of sufficient working capital helps in facing the expenses of unforeseen contingencies like seasonal fluctuations, depression, financial crisis occurring from huge losses etc. They can easily overcome these unfavourable situations if sufficient funds are available and continue with their activities.