Question

If a company has a very risk averse, cautious manager, what is his/her approach to managing the working capital? (Include a discussion of the level of current assets vs. level of current liabilities that the cautious manager would hold).

Answer 1

Working capital is the net of current assets & current liabilities, ie. Net assets.

It is needed for day-to-day running of the operations, to carry on which the business is specifically formed.

Examples of current assets are cash,merchandise inventory ,accounts receivables, short-term investments, prepaid assets , etc.

Examples of current liabilities are accounts or trade payables, accrued expenses payable with in a year,income taxes payable & all other short-term liabilities.

A particular level of investment in the above assets as also incurring upto a certain level of current liabilities --are considered optimal ,sub-optimal or adventuristic.

A risk -averse manager will tend to retain more cash , ever in-readiness to meet current obligations.

He may delay collections of receivables losing customers , in the event of facing their antagonism.

He is likely to hold more than adequate stocks of inventory for fear of losing sales on account of stock-outs.

Similarly, he ,in all probability will go in for very secure , but low interest-earning short-term investments, to be safe& sound.

Also on current liabilities, he will ensure payments on all accounts, like trade payables & accrued expenses , on or before time, with a view to ensure smooth functioning.

Thus, a risk-averse manager will have more of current assets than optimally required and less of current liabilities, that is actually possible & prudent also.

Profitable investing of cash in proper marketable securities , quick collections of receivables,carrying just adequate quantum of inventory & taking maximum advantage of trade credits offered (so as to ensure cash flow with in the company) --are some of teh best strategies for efficient working capital management.

To achieve this, the manager should take into account , the risks involved , and yet be on the look -out for carrying optimal levels of net working capital--so that his organisation , neither loses out opportunities nor incurs loss by being over-ambitious.