Question

Working capital management is the management of a firm’s short term assets and liabilities. It seems like we hear more about a firm’s long-term strategies and plans when discussing their success or failure. Why is working capital management crucial to a firm’s success? What factors must the company consider when making working capital decisions?

Answer 1

Working capital management relates to short term financial planning of the firm. Long term business decisions determine the need of short term working capital planning and management. Working capital management takes care of the regular financial requirement of the firm.

Net working capital = Current assets – Current liabilities

The gap between current asset and current liability is financed by borrowing or bank credit.

It is crucial to have effective working capital management process. The effective working capital management helps organization to avoid financial stress which arises on account of financial needs and gap arising due to current asset and liability mismatch.

Factors to be considered while making working capital decision:

1)      Nature of business: The businesses involved in manufacturing requires more working capital than business which are in service sectors. While considering the working capital requirement the management should take in account the nature of business and its financial cycle in consideration.

2)      Credit policy: Few businesses are bound to give a good credit term to their customers to boost the sales. This is done by attracting customers on liberal credit policies hence the management should maintain a balance of such policy so that it doesn’t affect finances of the business.

3)      Financial terms: The management should evaluate different banks and financial institutions to get good financial terms for their working capital finance. A good financial negotiation helps business in long term.

4)      Effective recovery team: The effectiveness of recovery team does matter in making working capital decision. Timely recovery is key for any business to the run the show hence effectiveness of recovery team is very crucial.

5)      Effective gap management: Working capital management is all about managing financial gaps through banking finance. The treasury manager should be able to manage working capital requirement effectively and times so that business doesn’t fall in financial stress.