4 Components of Working Capital Management

What is Working Capital Management?

Working capital management refers to all aspects of the administration of both current assets and current liabilities. The basic objective here is to manage the firm’s current assets and current liabilities in such a way that a satisfactory level of working capital is maintained i.e. it is neither inadequate nor excessive.

If the current assets are not sufficient to cover current liabilities the liquidity of the business is affected and there is no safety margin.

On the other hand, if the working capital is excessive, the firm’s profitability is affected. It is also necessary that different components of working capital are properly balanced. For instance, a firm’s liquidity will be low despite sufficient working capital if the amount of obsolete/slow-moving inventory is very high.

Components of Working Capital Management

A brief description of managing different components of working capital management is given below:

  1. Management of Cash
  2. Management of Inventory
  3. Management of Accounts receivable
  4. Management of Accounts Payable

Management of Cash

It is necessary to maintain adequate cash to pay current liabilities and to meet unexpected contingencies. At the same time, idle cash should be avoided as it means loss of income.

Cash management involves (a) controlling the level of cash through cash budgeting, and cash flow statement contingency arrangements with banks, etc. (b) controlling cash inflows through decentralized collection of bank debts, etc. (c) controlling cash outflows through centralized disbursements, etc. and (d) investing surplus cash appropriately.

Management of Inventory

Inventories constitute the principal item in the working capital of the majority of trading and industrial companies. In inventory, we include raw materials, finished goods, work-in-progress, supplies, and other accessories. To maintain the continuity in the operations of a business enterprise, a minimum stock of inventory is required.

The physical control of inventory is the operating responsibility of the store superintendent, and financial personnel have nothing to do with it. However, the financial control of these inventories in all lines of activity in which they comprise a substantial part of the current assets is a frequent problem in the management of working capital.

Management of inventory is designed to regulate the volume of investment in goods in hand and the types of goods carried in stock to meet the needs of production and sales while at the same time, the investment in them is to be kept at a reasonable level.

Management of Accounts receivable

Account receivables constitute a significant portion of current assets. A firm sells goods on credit to increase the volume of sales. But it involves loss of interest and risk of bad debt. The objective of receivables management is to ensure that the cost involved in financing bank debts does not exceed the income from investment in book debts.

The size of accounts receivable depends on the level of credit sales, credit period, terms of credit, cash discount offered, and efficiency of collection. In order to minimize investment in accounts receivable without sacrificing the firm’s competitive position, it is necessary to lay down specific credit standards, adopt a sound credit policy, and adopt efficient collection procedures.

Management of Accounts Payable

Working capital requirements can be reduced by obtaining liberal terms of credit from suppliers. While managing accounts payable the saving of interest cost through delayed payments should be offset against the loss of credit standing of the firm. Thus, effective management of working capital involves the following measures.

  1. Controlling the amount of cash in hand and cash at the bank through speedy collection of money from debtors and checking untimely outflows of cash.

  2. Forecasting cash needs to identify surplus cash that can safely be invested for a temporary period to earn income.
  3. Budgeting the raw material needs and devising a proper system of inventory control.
  4. Ensuring uninterrupted operations to minimize blockage of working capital in work in progress.
  5. Expediting dispatch of finished goods to realize cash fast.
  6. Ensuring proper balance between different components of working capital.
  7. Blending judiciously the different sources of working capital so as to minimize the cost of raising such capital.

FAQs Section

What are the components of working capital management?

The following are the components of working capital management:
1. Management of Cash
2. Management of Inventory
3. Management of Accounts receivable
4. Management of Accounts Payable.

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