Question

Why is working capital management one of the most important and time-consuming activities of the financial manager? Explain net working capital.

Answer 1

Working capital management is the administration of current assets and current liabilities. It deals with the management of current assets and current liabilities and directly affects the liquidity and profitability of the company.

To reach optimal working capital management, firm manager should control the trade-off between profitability maximization and liquidity accurately. Excessive levels of current assets can easily result in a firm's realizing a sub-standard return on investment. However, firms with too few current assets may incur shortages and difficulties in maintaining smooth operations.

Maintaining Trade-off

The working capital management of a firm in turn affects its profitability. The ultimate objective of any firm is to maximize profit. At the same time, preserving liquidity of the firm is an important objective too. The problem is that increasing profits at the cost of liquidity can bring serious problems to the firm.  Therefore, there must be a trade-off between these two objectives of firms. One objective should not be fulfilled at the cost of the other since both are important. If we do not care about profit, we cannot survive for a longer period. On the other hand, if we do not care about liquidity, we may face the problem of insolvency or bankruptcy. For these reasons working capital management should be given proper consideration and will ultimately affect the profitability of the firm. Firms need to have the optimal level of working capital that maximizes their value.

Constant Monitoring

Working Capital Management requires monitoring a company's assets and liabilities to maintain sufficient cash flow for smoothly run the company's day to day operations. Company must also prepare reliable cash forecasts and maintain accurate data on transactions and bank balances