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- Current assets are those liquid assets of the company which are either held in the form of cash or can be easily converted into cash within one accounting period, usually a year. Examples of current assets are cash, short-term investments, sundry debtors or accounts receivable, stock, loans and advances etc.
- Current liabilities have to be paid within the accounting period like sundry creditors or accounts payable, bills payable, outstanding expenses, short-term loans, etc.
- Working capital management involves not only managing the different components of current assets, but also managing the current liabilities, or to be more precise, the financing aspect of current assets.
- The basic objective of working capital is to provide adequate support for the smooth functioning of the normal business operations of a company.
- Management of current assets leads to a trade-off between 'profitability' and 'liquidity'.
- An aggressive approach to working capital management results in greater profitability but lower liquidity while a conservative approach results in lower profitability but higher liquidity.
- Under moderate approach some liquidity and profitability have to be sacrificed so that the resultant figures of liquidity and profitability are reasonably satisfactory to the company.
- Working capital management encompasses the management of current assets and the means of financing them.
- The objective of working capital management is one of balancing the 'liquidity' and 'profitability' criteria while taking into consideration the attitude of management toward risk and the constraints imposed by the banking sector while providing short-term credit in the form of cash credit/bank overdraft.
- Gross working capital is equal to the total of all current assets (including 'loans and advances') of a company.
- Net working capital is defined as the difference between gross working capital and current liabilities (including 'provisions').
- The dynamic approach to working capital is far more useful from the point of view of managerial decision-making than the static approach.
- Nature of business, Nature of Raw material used, process technology used, Nature of finished goods, degree of competition in the market, paying habit of customers and degree of synchronization among cash inflows and outflows are some of the factors affecting the composition of working capital management.
- Operating cycle approach proves quite useful as a technique for exercising control over working capital.
- Liquidity, availability of cash, inventory turnover, credit extended to customers, credit obtained from suppliers, undertrading and overtrading are some of criteria on which working capital management is evaluated.
- A situation of understanding arises in a company when the volume of sales is much less than the amount of assets employed.
- Undertrading also indicates that funds of the company are locked up in current assets resulting in a lower turnover of working capital.
- Overtrading is a situation which is the opposite of undertrading. The symptoms of over-trading can be noticed from the disproportionately high turnover of assets compared to the volume of sales.
- Precautionary measures for overtrading can be taken by initially reducing the sales to a level commensurate with the amount of assets and a final solution lies in increasing the asset base through additional finance raised through the issuance of shares and/or obtaining loan funds.