SIZE OF CURRENT ASSETS The issue of the size of the current assets primarily involves two questions.

First, how the size can be assessed? Second, whether the size is optimal in relation to the fixed assets? These two questions need some explanation here.

ASSESSMENT OF THE SIZE: THE CONCEPT OF OPERATING CYCLE The desired size of the current assets is assessed on the bases of the length of the operating cycle. Besides the use of cash for routine expenses, it is also used to acquire raw material is converted into the finished product it is sold on credit creating accounts receivable. Accounts receivables are collected after a specific period of time thus again taking the form of cash. The movement of cash into different forms of current assets ultimately once more taking on the form of cash is known as operating cycle. The longer the operating cycle (involving larger number of days) the larger is the size of current assets inasmuch as cash is tagged for a longer period of time. This is because, in a going concern, fresh doses of where per day credit sales divide by 365. The total number of days computed in this way reveals the length of the operating cycle. Inventory conversion period

+ Debtor conversion period

= Gross operating cycle

Payables deferral period

= Net operating cycle or cash conversion period

RATIO BETWEEN CURRENT ASSETS AND FIXED ASSETS: LIQUIDITY VERSUS PROFITABILITY A firm needs both fixed assets and current assets in order to support a specific level of output. Again, with the same amount of fixed assets, the amount of current assets may be different depending upon a host of factors. The most important is the trade-off between the risk and return or the trade-off between the liquidity and profitability. It is such trade-off that tends to optimise the size of current assets in relation to the fixed assets. Optimisation lies at the core of the working capital management. This is because there are inherent dangers in cases where the size of the current assets is either in excess of or less than the optimal size. If it exceeds the optimal size sufficient liquidity is generated in the form but the cost of holding and financial current assets grows large enough to bring down the profits. Chances of mishandling, theft and wastage of inventory may also increase. It may lead to complacency among the managers that may cause a fall in managerial efficiency. Again, excessive working capital may manifest itself in a liberal credit policy accompanied by greater incidence of losses caused by bad debts. All this entails upon the return from investment. On the contrary, inadequate working capital leads to illiquidity causing