Working Capital Management: A key to business success

TallyDekho is here to educate the readers about Working Capital Management and in this article, we’ll learn how it’s a success key for your business.

In every business, there are two types of assets and liabilities, long-term (non-current) and short-term (current). The long-term assets and liabilities are subjected to the duration of more than 1 year, whereas the short-term fosters the time duration of less than 1 year. And working capital constitutes the current assets and liabilities i.e, short-term.

Let us understand what is working capital management and its composition in detail for better understanding.

What is Working Capital Management?

The capital required in business to run day-to-day business operations is said to be working capital of the business. And, as this capital is used in daily business operations, it is usually liquid in nature. Broadly speaking, there are two categories of working capital:

Based on capital

• Gross Working Capital

The sum total of a company’s current assets( short-term assets) is known as gross working capital. It constitutes cash and cash equivalents, receivables, marketable securities, and short-term investments as well.

Gross Working Capital = Sum of all the current assets

• Net Working Capital

Net Working Capital is the aggregate of current assets minus current liabilities. Basically, net working capital helps in measuring the short-term liquidity of the business. Also, it acts as a mirror for the business to see whether it is successful in utilizing the assets effectively and efficiently.

Net Working Capital = Current Assets — Current Liabilities

However, a positive net working capital shows that the company has sufficient funds to manage all types of current financial obligations.

Based on the time period

• Fixed Working Capital

It is the minimum investment that has to be remain fixed in the business activity irrespective of any changes that take place in the ordinary course of business.

• Variable Working Capital

The capital required above fixed working capital that is fluctuating according to the changing business operations. This capital keeps on changing according to business needs.

Here you can see how important is working capital for the smooth running of the business. Therefore, being a crucial component of business, working capital management has been captivated in every business segment.

Working capital management is basically a business strategy that ensures the effective and efficient utilization of business current assets and liabilities.

• Objective

The primary motive of working capital management is to maintain sufficient liquidity for meeting short-term costs and other short-term obligations fostering the smooth functioning of business operations

Classification of Working Capital Management Ratios

Basically, there are four major ratios in working capital management. They are as follows:

• Current Ratio
• Trade Receivables Ratio
• Trade Payables Ratio
• Inventory Turnover Ratio

Components of Working Capital Management

A successfully running business will always try to maintain a balance among all the important components of working capital management. Let us have a look at them:

Cash Management

Cash is considered one of the most crucial components of working capital as it is required at all levels of business operations. From the acquisition of the raw materials to the product advertising, every single operation needs cash. Therefore, it is very important to maintain an adequate cash balance by matching cash inflows and outflows.

Accounts Payable Management

Accounts payable arises when a firm purchases raw materials or any goods on credit. Bills payable and creditors are a very crucial part of the business being a major source of financing for working capital requirements. An effective accounts payable management means timely meeting all the obligations towards creditors, therefore building a good reputation and creditworthiness.

Accounts Receivable Management

Accounts receivable arise when a firm sells goods and services to the customers on credit. Receivables are generally referred to as debtors. An efficient accounts receivable management ensures that debtors are meeting their payment commitment on time and keep on managing the lagging period accordingly.

Inventory Management

Inventory constitutes a major part of working capital as every business operation revolves around inventory. Under inventory management, two prospects are covered:

• Minimizing the inventory cost
• Availability of raw materials for timely meeting the sales deadlines

The complete working capital management revolves around these four components and an ideal working capital management system fosters maintaining balance among all of these. This way you can maintain a healthy business environment with efficient management of working capital of business. Stay connected for more interesting articles. Feel free to share your feedback.