Introduction of Working Capital Management

Working capital management is the device of finance. It is related to manage of

current assets and current liabilities. After learning working capital management,
commerce students can use this tool for fund flow analysis. Working capital is very
significant for paying day to day expenses and long term liabilities. 

Meaning and Concept of Working Capital and its management

Working capital is that part of company’s capital which is used for purchasing raw
material and involve in sundry debtors. We all know that current assets are very
important for proper working of fixed assets. Suppose, if you have invested
your money to purchase machines of company and if you have not any more money
to buy raw material, then your machinery will no use for any production without raw
material. From this example, you can understand that working capital is very useful
for operating any business organization. We can also take one more liquid item of
current assets that is cash. If you have not cash in hand, then you can not pay for
different expenses of company, and at that time, your many business works may
delay for not paying certain expenses. If we define working capital in very simple
form, then we can say that working capital is the excess of current assets over
current liabilities. 

Types of Working Capital 

1. Gross working capital

Total or gross working capital is that working capital which is used for all the current
assets. Total value of current assets will equal to gross working capital.

2. Net Working Capital

Net working capital is the excess of current assets over current liabilities.

Net Working Capital = Total Current Assets – Total Current Liabilities 

This amount shows that if we deduct total current liabilities from total current
assets, then balance amount can be used for repayment of long term debts at any
time.
3. Permanent Working Capital

Permanent working capital is that amount of capital which must be in cash or

current assets for continuing the activities of business.

4. Temporary Working Capital

Sometime, it may possible that we have to pay fixed liabilities, at that time we need
working capital which is more than permanent working capital, then this excess
amount will be temporary working capital. In normal working of business, we don’t
need such capital.

In working capital management, we analyze following three points

Ist Point 

What is the need for working capital?

After study the nature of production, we can estimate the need for working capital.
If company produces products at large scale and continues producing goods, then
company needs high amount of working capital. 

2nd Point

What is optimum level of Working capital in business?

Have you achieved the optimum level of working capital which has invested in
current assets? Because high amount of working capital will decrease
the return on investmentand low amount of working capital will increase the risk of
business. So, it is very important decision to get optimum level of working capital
where both profitability and risk will be balanced. For achieving optimum level of
working capital, finance manager should also study the factors which affects the
requirement of working capital and different elements of current assets. If he will
manage cash, debtor and inventory, then working capital will automatically optimize.

3rd Point

What are main Working capital policies of businesses? 

Policies are the guidelines which are helpful to direct business. Finance manager can
also make working capital policies. 
1st Working capital policy

Liquidity policy

Under this policy, finance manager will increase the amount of liquidity for reducing
the risk of business. If business has high volume of cash and bank balance, then
business can easily pays his dues at maturity. But finance manger should not forget
that the excess cash will not produce and earning and return on investment will
decrease. So liquidity policy should be optimized.

2nd Working Capital Policy

Profitability policy

Under this policy, finance manger will keep low amount of cash in business and try
to invest maximum amount of cash and bank balance. It will sure that profit of
business will increase due to increasing of investment in proper way but risk of
business will also increase because liquidity of business will decrease and it can
create bankruptcy position of business. So, profitability policy should make after
seeing liquidity policy and after this both policies will helpful for proper management
of working capital.