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Website design By BotEap.comFinancial management decisions are divided into the management of assets (investments) and liabilities (sources of financing), long-term and short-term. It is common knowledge that the value of a company cannot be maximized in the long term unless it survives in the short term. Businesses fail more often because they cannot meet their working capital needs; therefore, good management of working capital is a prerequisite for the survival of the company.
Website design By BotEap.comAbout 60 percent of a finance manager’s time is spent managing working capital, and many potential employees in finance-related fields will find that their first assignment at work will involve working capital. For these reasons, the policy and management of working capital is a fundamental subject of study. In many textbooks, working capital refers to current assets, and net working capital is defined as current assets minus current liabilities. Working capital policy refers to decisions related to the level of current assets and the way in which they are financed, while working capital management refers to all those decisions and activities that a company undertakes to manage efficiently the items of current assets.
Website design By BotEap.comThe term working capital originated with the old Yankee peddler, who loaded his wagon with merchandise and then set off on his route to sell his wares. The merchandise was called working capital because it was what he actually sold, or “delivered,” to produce his profits. The cart and the horse were his fixed assets. He generally owned the horse and cart, so they were financed with “equitable” capital, but he borrowed the funds to buy the merchandise. These loans were called working capital loans and had to be repaid after each trip to show the bank that the credit was strong. If the street vendor could repay the loan, then the bank would issue another loan, and these were sound banking practices. The days of the Yankee peddler are long past, but the importance of working capital remains. Current asset management and short-term financing remain the two staples of working capital and a daily headache for financial managers.
Website design By BotEap.comWorking capital, sometimes called gross working capital, simply refers to the company’s total current assets (short-term ones), cash, marketable securities, accounts receivable, and inventory. While long-term financial analysis is primarily concerned with strategic planning, working capital management deals with day-to-day operations. Ensuring that production lines do not stop due to a lack of raw materials, that inventories do not pile up because production continues unchanged when sales drop, that customers pay on time, and that there is enough cash available to make the payments when they are due. Obviously, without good working capital management, no company can be efficient and profitable.
Website design By BotEap.comStatements about the flexibility, cost, and risk of short-term versus long-term debt depend, to a large extent, on the type of short-term credit actually used. Short-term credit is defined as any liability originally scheduled for payment within one year. There are numerous sources of short-term funds, such as accruals, accounts payable (business credit), bank loans, and business paper. The main elements of current liabilities are trade creditors and bank overdrafts, which are analyzed in greater depth.
