Question

Accounting and Finance:

Explain why Working Capital Management is an integral part in financial management of a company especially in today’s circumstances with example.

Answer 1

Working Capital Management is an integral part of financial management because it is basically the management of cash. Companies require cash for day to day operation. So if WC management is not done then a cash crunch situation may arise. In the current situation due to a fall in demand and lockdown, the cash generation ability of the companies has been affected. But there are several fixed costs and interest costs which have to be paid. So to address this type of real-life problems WC management is done.

Some of the importance of WC management are listed below and explained in detail

1. Managing procurement and inventories: Keeping more inventories blocks the cash whereas maintaining less inventory could result in fewer sales and damage to customer relationships. So optimum stock level should be maintained which could be done by JIT (just in time strategy) or improving the communication between the forecasting team and the external suppliers which would reduce the lead time. It will also help in the reduction of storage cost, insurance cost, and chances of inventory getting obsolete.
2. Improving the Receivables and collection efficiency: In cash to cash cycle, the collection period is a major component, and the lesser the collection period better it is for a company as the cash blockage period is less. The company can hire an external collection agency to accommodate an efficient collection system in place. Delivering invoices electronically reduces the margin of error and speeds up the billing and collection process. Maintaining an accurate debtor ledger also says with whom a large chunk is pending and should be collected as soon as possible.
3. Negotiation with vendors would allow enjoying more credit period: For this, a company needs to have a good history of repayment which would reflect a discipline in it. It has a huge impact on the cash cycle as on increasing the payment period or credit period the cash cycle reduces so they share an inversely proportional relationship. Companies that pay on time develop better relationships with their suppliers and are in a stronger position to negotiate better deals, payment terms, and discounts.
4. Managing the debtors of the company effectively: Working capital management means proper utilization of money by improving the cash cycle and cash management so that a situation like cash crunch doesn't happen in the company. So it is very essential to see whether the credit period window provided to the debtors is not too big. Also, multiple financial checks like liquidity position and repayment history of the customer should be done to avoid bad debts as it is a loss for the company.