Question

Evaluate the effects of working capital management on business profitability ?

Answer 1

Solution:-

Effects of working capital Management in business profitability

Working capital means the capital available in the business which is used in the day to day operation of the business. Working capital is the difference between current assets(Cash and cash equivalents, Sundry Debtors, Inventories etc.)and Current Liabilities(Creditors, Outstanding Expenses ).The management of working capital in a better manner is very essential to the business to run for a long period .

Working capital is the life blood of an organization. Without the proper usage of the same the organization will enter in to a huge financial crisis. Every Organization shall maintain working capital ratio in to 2:1.It is the satisfying ration of working capital management. This ratio means the organization available $2 to pay off Liability of $1.Here in the above introduction we said that the working capital is the difference between the Current assets and Current Liabilities. If uses the available working capital to pay off the Long term loans or working capital used for Purchase of Long term fixed assets. In such a cases the Organization will enter in to working capital shortage. Such cases the organization may not be able to pay off their creditors and outstanding etc.. if creditors not paid off it will leads to Inventory shortage. Creditors will not provide stock for Trading and production it will happens to stop production .Here we can see that the available current assets(Cash and cash equivalents, Debtors, Inventories Etc..)shall be used to pay off the current liabilities(Accounts payables, Outstanding’s) and the working capital ratio shall maintain at 2:1 ratio. If the Organization have current ratio more than the above, then they can use the available working capital for other purpose also.

From the above we can understand that the relevance of working capital management is a better manner. Working capital management is very essential for every organization for healthy performance. Shortage of working capital may leads to bad impression with the creditors and this may leads to inventory credit facility that will leads to stop production and trading .If the Organization stops production effects the profitability of the Organization.