MANAGEMENT OF WORKING CAPITAL Financial Management MANAGEMENT OF WORKING CAPITAL

What is Working Capital? Working capital typically means net current assets which are available for day-to-day operating activities. It normally includes inventories, receivables, cash (and cash equivalents), less payables. Working capital = inventory + receivables + cash – payables

Investment in Working Capital? Working capital needs financing, just as does the investment in machines. Investment Fixed Assets Earn Profits Investment in working capital does not directly earn profits. If this were the only consideration, then it would be better to invest all the finance available in fixed assets and to keep working capital to an absolute minimum Working capital = receivables + cash + inventory – payables

Working Capital Trade-off Profitability Liquidity Optimum Level of Working Capital The company therefore faces a trade-off between profitability and liquidity, and it is up to the financial manager to decide on the optimal level of working capital and to ensure that it is managed properly

What is Working Capital? On the other hand, all companies need some working capital in order to keep the business running Customer Customers should be allowed to buy on credit, otherwise company would lose business to competitors Inventory Company’s need to carry inventories of finished goods in order to be able to fulfil demand Cash they need to have a short-term cash balance in order to be able to pay their bills

Financing of Working Capital Long Term Financing Equity shares or Long-term borrowings Expensive and less risky as it is repayable on an agreed period Long Term Assets – Fixed Assets Short Term Financing Overdraft Delaying payments to creditors Cheaper and risky as it is repayable on demand Short Term Assets - Inventories

Financing of Working Capital Permanent Working Capital Working Capital Remains Fixed Long Term Finance Through Long Term Financing Temporary Working Capital Day-to-day fluctuation of Working Capital Short Term Finance Through Short Term Financing