Working Capital Management (WCM)

WCM is one of the most important areas of corporate finance. Basically it is all about the management of current asset and current liabilities. In order to have a sound short-term capital management a strong commercial finance strategy must be laid on. The major goal of WCM is to satisfy the short-term fund requirement for the corporate smooth operation.

Working Capital:- this refers to fund which is required by an organization to meet its day-to-day operational expenses or funding the process of raw material conversion into finished goods. The prime elements of working capital are inventory levels, account receivables and account payables. The better a company manages its working capital, the lesser it needs to borrow. Thus it can improve its profitability and market. Those companies which are having surplus funds requires good working capital management for its reinvestment into worthy assets for better returns to investors.

Company to company WCM is different.

Take the case of an commercial finance company which receives premium upfront, but still they have manage

their working capital requirements which may arise due to claims generated by the clients. Where as biggest retailer like Wal-Mart Inc does require greatest attention towards its inventory levels. They have to put rigorous efforts for its management; even the customers use to pay spot cash for their purchase. So major difference in working capital management among the companies will depend on the nature of the business they undertake.

The firms use to hold cash. Why

There are basically three major reasons for holding cash by the firm according to Keynes. They are as follows

Speculation:- according to JM Keynes the important reason for holding the cash by the company is to facilitate ability to act quickly to take the advantage of special opportunities which may favor the corporate financial wealth in future. For example, purchase of extra inventories when prices are down, so that the benefit arises out of this purchase will overtake the inventory carrying cost.

Precaution: - secondary reason given by JM Keynes is to hold cash for meeting the emergency situations. Eg:- Assume expected cash inflow has not come at right time, for meeting the obligation time being the cash held by the firm will become useful in order to maintain smooth relation with the supplier.

Transactions:- all firms are engaged in economic activities either manufacturing or service providing, so these transaction involves and requires cash inflow as well as outflows. So maintaining smooth flow of operation some amount cash/fund has to be maintained by the firm.

Float:- the difference between your book balance and bank balance is called float. Assume that your fir has got a bank account with 0% interest rate and have a balance of $ 50000.

Now your firm received an electricity bill worth $2000 and you have written the check for the same. That day itself you would have debited your account with that $2000, so there will be a difference between your book and bank balance. As you have mailed that $2000 check, assume that it will take another 20 days to reach for collection. So for next 20 days that $2000 you can use for meeting other immediate requirement and should redeposit before the check comes for collection.

Sales:- for better cash management the credit period must be minimized or the collections from the clients must be made at the earliest by offering certain discounts or benefits. But this discount must be at least at par or greater than the cost of working capital.

Inventory: - The important goal of working capital management commercial finance is to have a sufficient liquidity in order to achieve perfect flow of operations. Just In Time system will help to reduce the inventory carrying cost. This is a system where raw materials or inputs are purchased or will be ordered when it is needed or just in time according to the production requirement.

In order to manage and utilize funds at its best level towards its operation a corporate requires sound policy. It must specify clearly the goal of working capital management. Proper planning of entire operation of WCM must be made before setting up the systems.

WORKING CAPITAL MANAGEMENT includes

1. WORKING CAPITAL CYCLE:- the entire cash flows in a cycle into, out or around of business. Finance is the lifeblood of business, and prime duty of finance manager is to utilize or deploy funds in such away so that it can generate maximum return to commercial finance.

2. Additional working capital: -

* Existing cash reserve

* Plough back of profits

* Credit from suppliers

* Equity or debt

* Bank OD

* Long term loans

3. Debtor management

4. Creditors management

5. Inventory Management

* Stock turnover ratio = average stock 365/ cost of goods sold

* Debtors ratio= average debtors 365/sales

* Payable ratio=creditors 365/cost of sales

* Current ratio=current asset/current liabilities

* Working capital ratio=(inventory + receivable-payables)/sales