Question

Why effective maintenance of working capital is necessary in a business? List and explain major sources of inward cash flow in a business.

Answer 1

Importance of Working Capital

Before understanding importance of working capital inn any business or why working capital management is so much necessary, let us understand what is working capital consists of.

Working capital is difference of short term assets or current assets and current liabilities or short term liabilities. By short term we mean one year or less.

Efficient working capital is necessary because of following reason

1. Smooth Running of Business –Sufficient working capital is required to run day to day operations of business, business should be capable of paying / settling the debt.
2. Requirement for ensuing solvency of business by maintaining required liquidity in working capital.
3. Important of keeping seasonality of business line in peak season when demand is high. Working capital is requirement is high and in low demand times the requirement of low.
4. To meet with urgent demand and remain in competition of market. Sometimes if we do not have sufficient working capital, we cannot meet up an immediate demand.
5. Working capital ensures solvency of business results in higher credit rating. If a business has higher credit rating, it will be easier to obtain loan on easier terms.
6. No stoppage or breakage in production, if we pay our supplier on timely basis.

Resources of Resources of cash Inflow –

1. Short Term Loan / borrowings from bank or financial institution
2. Timely collection from customer / Debtors
3. Term Loans
4. Retained Earning
5. Financing from long term assets on lease
6. Instalment credit
7. Financing of accounts payable / bills receivable