Working capital management is an integral component of the overall corporate strategies which aimed to create shareholders’ value. Working capital is the most crucial factor for maintaining liquidity, survival, solvency, and profitability of the business. Efficient working capital management is highly desirable for a firm’s growth and sustainability because of its effect on profitability and risk. Working capital management is important due to many reasons. Most of the manufacturing firms have current assets about half of the total assets. The day-to-day operating transaction of the firm is performed with the help of these current assets. An excessive level of current assets is generated idle funds from which no return is obtained. However, firms with too few current assets may hamper production, purchase, and sales. Efficient working capital management helps to maintain the desired level of working capital by removing the problem of the inadequate and redundant amounts of working capital. The profitability of a firm depends on the proper utilization of the current assets. Efficient working capital management involves the decision of the amount and composition of current assets and the financing of these assets. It helps to maintain the desired level of liquidity of the firm. The effectiveness of the fixed assets depends on the current assets. Working capital management makes a required change in working capital by keeping consistency with the changes in the degree of effectiveness of the fixed assets.
The basic objective of working capital management is to increase profitability without hampering the liquidity position of the firm in any way. A firm is required to maintain a balance between liquidity and profitability while conducting its day-to-day operations.
The main objective of working capital management is to maintain an optimal balance between each of the working capital components. Business success depends on the effective use of inventory, receivables, cash, and payables.
If the quantity of the inventory is very large, then the amount of profit the firm decreases because the excess money would be invested in another project and the inventory carrying cost will be increased, the capacity of meeting the short term obligation of the firm may be decreased. If more quantity of goods is stored for a long time then the qualitative standard of the goods is lost and they are sold at a lower price if their demand is decreased in the future. If the quantity of inventory is very low, the production function will be hampered due to lack of raw material and it will not be possible to fulfill the increased demand if suddenly the demand for the product increased. So the objective of inventory management is to maintain an optimum level of inventory by removing the problem of over stocking and under stocking so that continuity can be maintained in the production and sales smoothly.
If the credit policy of a firm is very simple and liberal, the volume of sales of that firm increases and as a result of this, the amount of profit increases. But if the volume of the credit sales increases, then the problem arises in debt collection, the risk of bad debt increases, collection cost increases; a large amount of capital is required for keeping unhindered the flow of sales and as a result of this also the amount of interest increases. The amount of profit decreases due to the combined effect of then. If the credit policy of a firm is rigid, the volume of sales of that firm decreases, and as a result of this, the amount of the profit is less. But in this case, the risk of bad debt decreases, collection cost decreases and interest cost on additional capital has not to be borne by the firm. The amount of profit increases due to the combined effect of them. So in order to ensure the desirable use of the working capital, the accounts receivables
should be managed properly.
The amount of cash in hand increases, the capacity of the meeting of the obligation of the firm increases but as no return is obtained from it, the internal rate of return decreases. On the other hand, if the amount of cash in hand decreases the internal rate of return to the firm increases but the capacity of meeting obligation decreases. So the objective of the cash management is to maintain a sufficient amount of cash balance so that the capacity of meeting the short-term obligations of the firm is not hampered and to maintain the desired level of cash balance so that no adverse effect is imposed on the earning capacity of the firm.
Another component of working capital is accounts payable. When the creditors follow a liberal credit policy for payment of their claims, the less will be the requirement of the amount of working capital. As a result of it, a large amount of cash is not to be invested in procuring raw materials. On the other hand, when the creditors supply raw materials by following liberal credit policy, then they charge a high price for their goods and they do not allow cash discount on the settlement of their claim. For this, the credit accepting policy should be accepted by maintaining balance among them.
For citing this article use:
- Rani, P. J. (2017). Impact of working capital management on the financial performance of some selected FMCG companies in India.
