WORKING CAPITAL: POLICY AND MANAGEMENT

The working capital management includes and refers to the procedures and policies required to manage the working capital.  It may be noted that the long term profitability of a firm, undoubtedly, depends upon the investment decisions of a firm.  The investment decisions determine the pattern of sales growth and sales in tern, determine the profitability.  However, the investment decisions and other decisions have two important implications for working capital management.  First, the sales forecast of goods and services being produced by the firm allow the financial manager to estimate the working capital needs and level of different current assets.  Second, the working capital management helps maximizing the shareholders wealth by providing and maintaining firm’s liquidity.  The working capital management need not necessarily have a target of increasing the wealth of the shareholders, nevertheless it helps attaining the objective by providing sufficient liquidity to the firm.

The importance of working capital management, thus, can be expressed in terms of the following points.

i)    The level of current assets changes constantly and regularly depending upon the level of actual and forecasted sales.  This requires that the decisions to bring a level of current assets to the desired levels of current assets should be made at the earliest opportunity and as frequently as required.
ii)    The changing levels of current assets may also require review of the financing pattern.  How much working capital needs to be financed by different sources of financing must be periodically reviewed.
iii)    Inefficient working capital management may result in loss of sales and consequently decline in profits of the firm.
iv)    Inefficient working capital management may also lead to insolvency of the firm if it is not in a position to meet its liabilities and commitments.
v)    Current assets usually represent a substantial portion of the total assets of the firm, resulting in investment of a larger chunk of funds in the current assets.
vi)    There is an obvious and inevitable relationship between the sales growth and the level of current assets.  The target sales level can be achieved only if supported by adequate working capital.  The increase in sales level requires increase in working capital and thus the financial manager must be able to respond quickly in providing and arranging additional working capital.

Thus, the efficient working capital management is important from the point of view of both the liquidity and the profitability.  Keeping in view the importance of working capital management, the financial manager should look into the framing of a suitable working capital policy for the firm. 

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