Working Capital Management Assignment
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ABOUT WORKING CAPITAL MANAGEMENT
The word “Working capital management” applies when a company’s managerial accounting policy invented to control and utilize the two segments of working capital, and current liabilities, current assets, to assure the most financially sound administration of the corporation. The principal objective of working capital management is to make convinced that a company always manages adequate cash flow to suffice its short-term operating expenses and short-term debt burdens. This type of management usually includes liabilities, assets and monitoring cash flows through ratio analysis which are some of the main primary elements of operating expenses including collection ratio, inventory turnover ratio as well as the working capital ratio. An effective working capital management helps in developing an organization’s smooth financial controlling mechanisms also helps in improving the profitability and earnings of a company or any business entity. Management of working capital mainly involves the systematic way of managing accounts receivables and payables plus inventory management too.
Commonly the formula which helps in calculating working capital ratio is current assets divided by current liabilities. Now coming to the point about working capital ratio as we have given the formula of it so this acts as a significant role in indicating the organization’s basic financial health. As this helps an organization to meet all of its financial obligations in time successfully. Still, numbers may vary from industry to industries, as it is being said when the ratio of working capital for a company comes below 1.0 then it is said that the company is having issues regarding meeting its short-term obligations, this usually happens because of insufficient cash flow. Desirable working capital ratios match up around 1.0 to 2.0, but a higher ratio which rises above 2.0 then it indicates that the company is unable to make the most efficient profit due to increased revenues.
The main and the final part of working capital management is inventory management, this helps in operating with maximum efficiency and maintains a standard level of working capital for a long time unless it is being converted to liquid cash. Inventory Ratio helps in maintaining the balance that how efficiently the company is working on its revenues. The formula by which inventory ratio is easier to calculate is revenues divided by inventory cost, this formula helps in revealing that how quickly the inventory of a company is being replenished and sold accordingly. Compared to industry peers a relatively low ratio indicates the stock level as expectantly high whereas a relatively high ratio indicates whether the stock levels of a company can be improved or not.
IMPORTANCE AND REQUIREMENT OF WORKING CAPITAL MANAGEMENT
Working capital is the life line of business. Working capital is necessary to maintain the smooth functioning of the business. Not a single business can run actively without a satisfactory result of working capital. Here are some principal advantages or importance of working capital is as follows:-
- ENHANCE GOODWILL – Satisfactory working capital allows a business affair to make quick payments hence assists in creating and managing goodwill. Goodwill is improved as all current liabilities, and operating charges are settled on time.
- REGULAR SUPPLY OF RAW MATERIAL– Immediate payment of credit acquisition of new materials assures the regular supply of raw supplies from suppliers. Suppliers or Vendors are pleased by the on time payment. It secures a steady supply of fresh elements and continuous generation.
- STRENGTHENING THE SOLVENCY– Working capital serves to operate the business easily without any financial dilemma for making the payment of short-term obligations. Purchase of raw materials and settlement of salary, wages, and expenses can be carried out without any pause. Adequate working capital helps in maintaining the solvency of the business by providing an uninterrupted flow of generation.
- SMOOTH OPERATION OF BUSINESS– Working capital is a salvation of any industrial association which manages the business in good condition. Any day to day financial requirement can be met without any shortage of fund. All investments and current liabilities are settled on time.
Working capital is a regular requirement for companies, as they need a usual amount of cash to make monthly payments, cover unanticipated costs and purchase necessary materials used in the generation of goods. Working capital is an effortlessly right concept, as it is connected to an individual’s cost of maintenance and, thus, can be interpreted in a more personal style. Individuals need to accumulate money they are owed and save a certain amount on a periodic basis to cover day-to-day costs, bills, and other general investments.
It is a common metric for the effectiveness, liquidity and overall strength of a company. It is a representation of the results of various business activities, including revenue acquisition, debt superintendence, inventory administration and settlements given to suppliers. As it involves inventory, accounts receivable and payable, cash, parts of debt outstanding within the time of a year and other short-term records.
Working capital varies from industry to industry, and they can also vary among comparable companies. Due to various factors, which includes the differences in accumulation and payment systems, the timing of the purchase of assets, the probability of a company signing off some of its past-due accounts receivable, and in some situations, capital-raising exercises a company is engaging.
When an organization does not have sufficient working capital to meet its responsibilities, financial distress can result and lead to legal problems, liquidation of assets and possible failure. Therefore, it is important to all industries to have a sufficient administration of working capital.
Working capital management is primarily an accounting policy with a center on the sustenance of an adequate balance between an organization’s current liabilities and assets. An efficient working capital management practice enables companies not only to cover their financial responsibilities but also gives a way to help businesses raise their profits. Managing working capital means maintaining inventories, investments, accounts receivable and accounts payable. An active working capital management operation often practices essential production ratios, such as the collection ratio, the inventory turnover ratio and the working capital ratio, which helps in identifying the necessary steps which are required to concentrate on maintaining profitability and liquidity.
AIM OR OBJECTIVE OF WORKING CAPITAL MANAGEMENT STUDIES
The main aim or the objective of working capital management is to manage and maintain the balance in such a way so that a business can meet it currently profitable requirements. By saying this we must also note that being in a liquidity state does not refer that it will affect or decrease the profitability of the business completely. Rather it will be able to maintain the balance by discovering ways in smoothing out cash settlements to manage and help in stabbing the working capital of a company. The importance of managing and maintaining good working capital management so that the company can work efficiently as well as survive its daily operations which in turn will lead to long-term success.
Every company should understand the importance of working capital management as it will help the company or any business entity to reach its aim and maintain the objective and work accordingly to get success every upcoming year. The amount of working capital that a company carries can be used during the time of any kind of anomalies or financial crisis. Therefore it is essential for every industry to maintain the perspective objective in such a way so that it will be easier to maintain and balance profitability and liquidity while a company is busy managing working capital. A well-managed working capital is essential for running a healthy and stable business successfully.
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