The Importance of Working Capital Management to the Survival of Business Organisations

Topics: Finance, Inventory, Investment Pages: 5 (1651 words) Published: August 29, 2011


Working Capital has been defined as the net asset of a business, that is, the excess of current assets over current liabilities. It is the resources required to conduct the daily of core activities of any business setup small businesses, medium businesses or large scale enterprises. Any business which desire to perpetually remain in business must ensure a healthy level of its working capital by maintaining a sound relationship between the current assets and current liabilities as required by various factors as defined by the market and its own policies. The finance manager has the responsibilities of carrying out careful analysis of every activity having financial implication on the company in order to check and control any under or over utilization of the organization’s resources which may have any shortcoming effects on the realization of the corporate goal. Every business needs finance for two purposes: * Long term financing which is required to provide facilities upon which the business will carry out its operations; and * Short term financing which the business needs for the recurring purchase of raw materials, payment of wages and salaries and other day-to-day expenses. It is referred to as revolving or circulating or working capital. It is simply the difference between the current assets and the current liabilities as defined above. As a business owner, you must constantly be alert to changes in working capital and their implications; otherwise, you may miss some warning signs that can lead to business failure. Performances of businesses in terms of profits made at a particular period, financial health and strength in terms of advantages over their competitors at any point in time are areas to which working capital contributions cannot be looked down upon. Hence, it is important for managers to ensure relentless efforts towards keeping a sound working capital level in order to optimally achieve organizational goals. An effective and efficient management of the working capital resources is a necessity for all forms business and sizes for continuous operation and favorable return on investment. This is known as working capital management. The manager takes several items which constitute working capital into consideration such as inventories, account receivables and account payables. In fact, these components of working capital are so important that analysts look to the combined health of all of these areas of operation as an indicator of an individual company's level of efficiency. It is a short term capital required to finance a firm on a day-to-day basis. It is a key measure of business liquidity. The more working capital a firm has, the less risk there is of the firm not being able to pay its creditors when the bills become due. Conversely the less working capital a firm has, the greater the risk of the firm not being able to pay its creditors when the bills are due. Working capital is an operational necessity (Fung, Hebb & Rogers 2001). A firm needs to invest in short-term current assets such as stocks and also needs debtors to allow it to perform its day-to-day operations. This investment in current assets is for the short term, as raw materials will be bought, converted into finished product, and sold to customers who ultimately will pay. For many businesses this cycle will be completed within a short timeframe, and will be repeated many times over during the year. For others, this cycle may become considerably extended. The investment in current assets requires to be financed and a primary source of this financing is the firm’s current liabilities, particularly the credit received from suppliers. In relation to shareholder value, the firm’s investment in working capital should produce cash returns that add to the market value of the firm and thus to the wealth of its shareholders. However, excessive investment in working capital will depress returns, by...
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