Question

Explain the concept of working capital and its importance to a corporation such as a medium sized energy firm (oil and gas manufacturer)   

Answer 1

Working Capital

Working Capital = Current Assets - Current Liabilities

As mentioned in above equation, the working capital is the difference of amount between current assets and the current liabilities. The working capital measure the company's efficiency to meets its short-term and current obligations.

Before judging why working capital is important to a corporation such as a medium sized energy firm (oil and gas) we need to understand an importance of working capital i.e described below;

The working capital is one of the portion of the total capital employed by a company and is often defined as the difference between current liabilities and current assets. In general terms working capital is the cash required to run the daily, weekly and monthly activities of a business. Therefore, it is utmost important that a firm has to have sufficient liquidity to run its operations smoothly.

So, the corporations such as a medium sized energy firm like Oil and Gas Manufacturing should focus on effective management for working capital as they involved various activities such as regular drilling, refining, marketing and meeting short term and regular versatile demand that requires a liquidity to run its operations smoothly. So, the following reasons made it clear why working capital is important for medium sized energy firms.

• If a company tied up a significant large amount of cash in working capital and managing it efficiently could benefit from additional liquidity and be less dependent on external financing. This is especially important for medium sized businesses as these businesses typically have a limited access to external funding sources. Also, it is equally considerable that medium sized businesses often pay their bills in cash from regular earnings so an efficient and effective working capital management will allow business to better allocate its resources and improve its cash management.
• The business managing their working capital more efficiently will generate more free cash flows which will result in a higher business valuation and enterprise value. The organisation such as oil and gas manufacturer need higher valuation because they involved various activities which require a large amount to conduct it day-to-day and regular activities such as drilling, refining and marketing of their products.
• The business, which paying its suppliers regularly on time will able to make good relationship with its trade partners and this will benefit in favourable financing terms such as discount payments from its suppliers and banking partners which could lead to increased profitability. As the medium sized corporation are growing in nature, so they will be definitely looking towards every opportunity to increase their profitability.
• As discussed above that the medium sized corporation such as oil and gas manufacturer are involved in the various activities which are important on day to day basis such as drilling, refining for production and improved distribution. Therefore, these businesses require uninterrupted production and continuation of all activities on regular basis. So, the corporation paying its trading partners on time will also benefit from a regular inflow of raw materials to ensure that the production remains uninterrupted and they deliver their product and service on time.