working capital management

Financial management decisions are divided into the management of assets (investments) and liabilities (funding sources) into long-term and short-term. It is well known that a company’s value cannot be maximized over the long term unless it survives in the short term. Businesses fail most often because they cannot meet their working capital needs; Consequently, sound working capital management is a prerequisite for the survival of a company.

About 60 percent of a finance manager’s time is devoted to managing working capital, and many prospective employees in finance-related roles will find that their first assignment on the job involves working capital. For these reasons, working capital policy and management is an essential subject of study. In many textbooks, working capital refers to current assets, and net working capital is defined as current assets less current liabilities. Working capital policy refers to decisions related to the amount of working capital and how it is funded while working capital management refers to all the decisions and activities that a company undertakes to efficiently manage the elements of working capital.

The term working capital comes from the old Yankee peddler who would load his cart with goods and then set off to sell his wares. The commodity was called working capital because it was what he actually sold or “turned over” to make his profits. The carriage and the horse were his assets. The horse and carriage were generally his, so they were financed with ‘equity’, but he borrowed the funds to buy the goods. These loans were called working capital loans and had to be repaid after each trip to show the bank that the loan was sound. If the peddler could repay the loan, the bank would make another loan, and that was sound banking practice. The days of the Yankee peddler are long gone, but the importance of working capital remains. Ongoing asset management and short-term financing remain the two basic elements of working capital and a daily headache for finance managers.

Working capital, sometimes called gross working capital, simply refers to the company’s total current assets (the current ones), cash, marketable securities, accounts receivable and inventory. While long-term financial analysis primarily concerns strategic planning, working capital management deals with day-to-day business. By ensuring production lines don’t stop for lack of raw materials, inventory isn’t built up because production stays the same when sales fall, customers pay on time, and there is enough cash to make payments when they’re due. Obviously, no business can be efficient and profitable without good working capital management.

Statements about the flexibility, cost and risk of short-term debt versus long-term debt depend in large part on the type of short-term credit actually used. Short-term loans are liabilities that are originally scheduled to be paid within one year. There are numerous sources of short-term funds, e.g. B. Provisions, trade payables (trade credits), bank loans and commercial paper. The main components of current liabilities are trade accounts receivable and bank overdrafts, which are analyzed further.