1.

1 The Importance of Working Capital Management

working capitalIt is the capital used to run the day-to-day business operations. Usually, the gap
between current assets and current liabilities is called working capital. Current assets include cash
and bank balance, accounts receivable, stocks or any other assets that can be liquidated within one
year. In addition, current liabilities are liabilities which are payable within one year.

The importance of working capital

Working capital is an important part of the business and can provide the following benefits to the
business.

 Higher return on equity

Firms with lower working capital will post higher returns on invested capital. Thus, the
shareholders will receive a higher return for every dollar invested in the business.

 Increase creditworthiness and solvency

The ability to meet short-term commitments is a prerequisite for long-term solvency. And it is
often a good indicator of the credit risk of the counterparty. Adequate working capital
management will allow businesses time to pay its short-term obligations. This may include the
payment for the purchase of raw materials, payroll and other operating expenses.

 Higher profitability

Managing accounts receivable and accounts payable is an important factor for the profitability
of small businesses.

 Higher liquidity

A large amount of cash can be connected in working capital, so the company managing it can
effectively benefit from additional liquidity and to be less dependent on external financing. This
is especially important for small businesses because they tend to have limited access to external
sources of financing. Furthermore, small businesses often pay their bills by cash earnings, effective
working capital management will allow businesses to better allocate their resources and improve
cash management.
  Increasing the value of the business

Firms with more efficient working capital management will generate more free cash flows,
which will lead to higher business valuation and enterprise value.

 Favorable financing conditions

The company has good relationships with its trading partners and pay your provider time to
benefit from favorable financing conditions, such as payment discounts from suppliers and
partner banks.

 uninterrupted production

The company pays its supplier at the time also will benefit from the regular flow of raw
materials, ensuring that production remains uninterrupted, and customers receive their goods on
time.

 Ability to face shocks and peak demand

Effective working capital management will help the company survive the crisis and to ramp up
production in the event of unexpectedly large order.

 Competitive advantage

Companies with effective supply chain will often be able to sell their products at a discount
compared to similar firms with inefficient sources.

1.2 Working Capital Management Components

Effective management of working capital is essential for the profitability and general financial
condition of any company. Working capital is the cash that the company used to operate and
conduct their business.

Aspects of working capital that investors and analysts estimate, to evaluate the company are key
elements in the company's cash flow - the money comes the money to go out and manage
inventory. This helps ensure that the company always maintains sufficient cash flow to meet its
short-term operating costs and short-term debt.
The four main components related to working capital management:

1. Cash and cash equivalents

One of the most important components of working capital to manage all cash and cash equivalents
organizations. cash management helps in determining the optimal size of the liquid balance of the
company's assets. This points to the appropriate types and amounts of short-term investments, as
well as effective ways to control the collection and disbursement of funds. Good cash management
involves the cooperation relationship between the maintenance of adequate liquidity with little
cash in the bank. All companies strongly emphasize cash management, as this is key to maintaining
the company's credit rating, to minimize interest expenses and avoid insolvency.

2. Receivables

Accounts receivable are the proceeds from the fact that - due to the Company from its customers
for sales made. Timely, efficient debt collection is essential for the smooth operation of financial
companies.

Accounts receivable listed as assets on its balance sheet, but they are not really assets until they
are collected. Conventional metric analysts use to assess the processing of receivables are days of
sales outstanding, which shows the average number of days the company takes to collect revenue
from sales.

3. Accounts payable

Accounts payable, the money that the company is obliged to pay in the short term, is also a key
component of working capital management. Companies strive to find a balance between
maintaining high cash flow by deferring payments until as far as reasonably possible, and the need
to maintain a positive credit ratings while maintaining a good relationship with suppliers and
creditors. Ideally, the average time for the collection of receivables the company is significantly
shorter than its average time to settle the debt.
4. Inventory

Inventory is the main asset of the company, which it turns into sales revenue. The speed with which
the company sells and replenishes its reserves is an important indicator of its success.

Investors believe inventories turnover to be a sign of the sales force and as a measure of how
effective the company is in the procurement and production process. Equipment which is too low
puts the company in danger of losing in sales but excessively high inventory levels are wasteful,
inefficient use of working capital.

1.3 Relationships with liquidity

Liquidity having money to pay the company's liabilities when they are due. In other words, it is
the company's ability to convert its current assets into cash so that the current obligations can be
paid when they come due. Liquidity is necessary for the company to continue its business
operations.

Liquidity may increase:

 The increase in working capital (see above list for the increase in working capital)
 Increasing the speed at which current assets are converted into cash
 Deferral of payment of current liabilities
 Deferral of payment of long-term liabilities
 Omitting the distribution of cash to owners

Liquidity may be reduced to:

 The decrease in working capital (see above list for the reduction of working capital)
 Buying and / or produce too many items for inventory
 Slowing down the speed at which current assets are converted into cash
 Payment of current liabilities too soon

Working capital as compared with liquidity

Retail, distributor or manufacturer may have a large amount of working capital. However, if the
majority of its current assets in the slow-moving inventory, the company may not have the liquidity
to repay their obligations under the agreed terms. Similarly, if the company is unable to collect its
receivables, it may not have the liquidity to pay its obligations.

In contrast, consider a company that sells popular products online and customers pay with bank
credit cards or debit cards when they order. In addition, the company's suppliers allow the company
to pay 60 days after he buys the products. This company may have very little in working capital,
but it can have the liquidity required.

Working capital is a commonly used metric, and not only on the liquidity of the company, but also
for its operational efficiency and overall financial health. working capital of the company is the
capital needed to operate on a daily basis, because it requires a certain amount of cash on hand to
cover unexpected expenses, recurring payments and buy the raw materials used in production.

Working as a liquidity measure

Working capital is the difference between the company's current assets and its current liabilities.
The ratio of working capital by the Decree of whether it is the analyst company's liquidity or cash
flow is sufficiently adequate to meet all of its short-term liabilities and expenses. It is calculated
by dividing current assets by current liabilities.

Working capital needed to operate a business varies between sectors. A number of factors affect
the working capital, including the purchase of assets, overdue accounts receivable (AR) is written
off, as well as differences in pay policy.

Working capital reflects the various activities of the company, such as debt management, tax
collection, supplier payments, and inventory management. These activities are reflected in
working capital, as it includes not only cash, but also accounts payable (AP) and the AR, inventory,
part of the debt within one year and some other short-term accounts.

For the company, liquidity essentially measures its ability to pay its liabilities as they fall due, or
how easily and efficiently the company can access the money it needs to cover its debts. Working
capital represents the liquid assets the company uses to make these debt payments.
1.4 Determinants of circulating management

Some of the most determinant of working capital are:

1. Nature of activity

This is an important factor in determining the amount of working capital required by different
companies. Commercial or industrial problems will require more working capital in their
investments in the fixed capital stock, raw materials and finished products. Utilities and railway
companies with huge investments in the share capital, as a rule, have the lowest need for working
capital, partly because of the money, the nature of their activity, and partly because of their selling
services instead of goods. Similarly, basic and key industries or those involved in the production
of producer goods, tend to have a smaller share of working capital in fixed assets than the industries
producing consumer goods.

2. The length of the production period,

The average duration of the production period, ie the time that elapses between the beginning and
end of the production process is an important factor in determining the amount of working capital.
If it takes less time to make a finished product, the working capital required will be less. For
example, the baker is required once a night to bake their daily bread ration. Its working capital,
therefore, is much less than that of the shipbuilding group, which takes three to five years to build
a ship. Between these two cases can fall other business problems with various production periods,
requiring high volumes of working capital.

3. The volume of business

Typically, the size of the company is directly related to the working capital. Big problems need to
have a higher working capital for investment in working capital and to pay current liabilities.

4. The share of raw material costs in the total cost

Where the cost of raw materials for use in the manufacture of the product is very large in relation
to the overall value and its final value, the working capital is also required to be more. That is why,
in the cotton textile factory or a sugar factory, the huge funds needed for this purpose. The building
contractor also requires a lot of working capital for this reason. If the value is less than the materials
as, for example, will, of course, no longer as an oxygen company, working capital needs.

5. The use of manual labor or mechanization

In labor-intensive industries need more working capital than in the highly mechanized ones. The
latter will have a large part of the capital. It may, however, be remembered that in some degree to
use manual labor or equipment rests with management. Therefore, it is possible, in most cases, to
reduce the requirements of working capital and increased investment in fixed assets, and vice
versa.

6. The need to keep large stocks of raw materials finished products

production problem as a whole should bear the stocks of raw materials and other shops, as well as
finished products. The more stocks (whether raw materials or finished products) is greater working
capital needs.

In some areas, for instance, when the materials are bulky and must be purchased in larger quantities
(as in cement production), used raw stock pile.

Similarly, in the area of public services, which should have sufficient coal reserves to ensure
regular maintenance, the accumulation of coal reserves is necessary. In seasonal industries of
finished goods inventory to be stored during off season. All this requires a lot of working capital.

7. Turnover of working capital

Turnover is the rate at which the extracted working capital purchase and sale of goods. In some
companies, sales are carried out quickly and stocks soon exhausted, and new purchases should be
made. Thus, a small amount of money invested in stocks will lead to the realization of a
significantly higher amount.

Given the volume of sales, the volume of working capital needs will be small enough in this kind
of business. There are other businesses, where sales are made irregularly. For example, if jewelers,
expensive jewelry can remain locked in the window for a long period before he catches fancy
ladies rich.

In such cases, large amounts of money to be invested in stocks. But the baker or a newspaper
delivery man may be able to dispose of their shares quickly and may, therefore, need to be much
smaller quantities by working capital.

8. Terms of the loan

The company buys all the raw materials for cash and credit sales will require greater amounts of
working capital. In contrast, if the company is able to buy on credit and sell it for cash, you will
need a smaller amount of working capital. The length of the loan period has a direct bearing on
the working capital. The bottom line is that the period that passes between buying materials and
selling the finished product and the receipt of proceeds from the sale, will determine the working
capital requirements.

9. Seasonal variations

There are some industries that either produce goods or make sales only seasonally. For example,
the sugar industry produces almost all the sugar in the period from December to April and a woolen
textile industry makes its sale, usually in winter. In both these cases, the need for working capital
will be very large, for a few months. working capital requirements will gradually decline, and
when sales are made.

10. Requirements of cash movement

The need to have cash in hand to meet the various requirements, such as payment of wages, rents,
interest rates, etc., has an impact on working capital. The more cash requirements to the higher
working capital of the company and vice versa.

11. Other factors.

In addition to the above reasons, there are also a number of other factors that affect the
working capital needs. Some of them are listed below.
(I) the degree of coordination between the production and distribution policy.
(II) Specialized in the distribution area.
(III) Development of means of transport and communications.
(IV) Risk and contingencies inherent in the type of business.

1.5 Working Capital Finance Policy

capital policy development involves decisions about the company's current assets and current
liabilities, that they consist of, how they are used, and how their combination affects the risk and
return characteristics of the company. Both conditions of working capital and net working capital
usually refers to the difference between current assets and current liabilities of the company. These
two terms are often used interchangeably.

Working Capital policy

Development capital policies through their impact on the expected future earnings of the company
and the risk associated with these returns, ultimately, have an impact on shareholder wealth.
Effective policy in working capital is crucial for long-term growth and survival of the firm. If, for
example, companies do not have enough working capital needed to expand production and sales,
it may lose revenue and profit. Working capital is used by companies to maintain liquidity, ie, the
ability to meet its financial obligations as they come due. Otherwise, it can bear the costs associated
with the deterioration of credit ratings, potential compulsory liquidation of assets and possible
bankruptcy.

Working capital management is a continuous process which includes a number of routine

operations and decisions which determine the following:

 The level of working capital of the company

 The proportions of short-term and long-term debt company will use to finance its assets
 The level of investment in each type of current asset
 Specific sources and the combination of short-term loans (current liabilities), the
company must use

Working capital is different from the fixed capital in terms of the time required to recover the
investment in the asset. In the case of equity capital or long-term assets (such as land, buildings
and equipment), the company usually requires several years or more to recover the initial
investment. Unlike working capital turns over, and distributed at a relatively fast pace. Investment
in inventories and accounts receivable are generally recovered within the normal operating cycle
of the company, when stocks are sold and receivables collected.

There are three strategies or approaches or methods of financing working capital - Maturity
Matching (hedging), conservative and aggressive. Hedging approach is an ideal method of
financing with moderate risk and return. Other two extreme strategies. A conservative approach is
highly conserved with a very low risk and, therefore, low profitability. An aggressive approach is
very aggressive, having a high risk and high return.

We compare these three sets of parameters is 5. liquidity, profitability, risk, use of assets and
working capital.

Three types of working capital policy

Based on the position of financial manager risk, profitability and liquidity, working capital policy
can be divided into the following three types.

 limited policies

The exclusion policy, assessment of working capital to achieve targeted revenue made very
aggressively, without taking into account any unforeseen circumstances and provisions for any
unforeseen event. After the decision, the policy to enforce the organization, not allowing any
abnormalities. Diagram R point is limited policy that achieves the same level of revenues low
current assets.

The adoption of this policy would lead to the preferential claim lower working capital due to a
lower level of current assets. This saves the cost of interest to the company and that, in turn,
produces higher yields ie higher return on investment (ROI). On the other hand, there is a drawback
in the form of high-risk because of the very aggressive policy. Therefore; it is also called the
aggressive policy of working capital.

 relaxation policy

Relaxation policy is directly opposed to the limited policy. In this policy, assessment of working
capital in order to achieve the target revenue is obtained after careful consideration of uncertain
events, such as seasonal fluctuations, sudden changes in the level of activity or sales, etc. After
reasonable estimates also cushions to avoid any unforeseen circumstances leave in order to avoid
the risk as much as possible. In the diagram, it is a point of Rx, which uses the highest level of
current assets to achieve the same level of sales.

Companies that have a relaxed policy of working capital to assume the advantage of virtually no
risk or low risk. This policy ensures the smooth functioning of the entrepreneur operating cycle.
We know that profits are more important than high returns. On the other hand, there is a lack of
low returns on investment as the growth of investment in current assets attracts a higher value of
the interest rate, which in turn reduces profitability. Because of its conservatism, this policy is also
called a conservative working capital policy.

 moderate policy

Moderate policy is a balance between the two policies, ie, limited and relaxed. It assumes the
characteristics of both policies. To strike a balance, moderate policy involves risk, which is lower
than the limited and more than conservative. The front margins also that lies between them. The
biggest advantage of this policy is that it has sufficient confidence in the smooth operation of the
operating cycle of capital with moderate profitability.

Development capital policy can be further decorated for each component of net working capital
cash, accounts receivable, inventory and accounts payable. Cash policy may be to maintain the
proper level of cash. When the level is high, it should be invested in liquid short-term investments,
and vice versa. Receivables policy may apply for terms of payment, term of the loan, credit limit,
etc. Inventory policies can talk about minimizing inventory levels to the point that it poses any
danger to meet customer needs. Payables policy includes policy terms of payment, conditions of
quality, return policy, etc.