Introduction to Working Capital Management
Major elements of working capital are
1) Cash 2) Marketable securities 3) Accounts receivable 4) Inventories 5) Current liabilities
Not overinvest in net working capital (assets) which provide low returns or increase costs
1) Excess idle cash—which has a low rate of return, if any 2) Excess accounts receivable—which do not earn interest 3) Excess inventory—which both incurs storage costs and risks becoming obsolete
Management of Net Working Capital provides
Another illustration of the trade-off between risk and reward in financial management
Current Assets definition
Cash and other resources expected to be converted to cash, sold, or consumed within one year
Current liabilities
Obligations due to be settled within one year
Working Capital (also called Net Working Capital):
The difference between a firm's current assets and its current liabilities.
The main concern of working capital is
To manage capital not the accounting
Over-investment in net working capital reduces the
rewards, which could be recognized by the firm through investment in assets with greater returns.
Current assets and current liabilities are considered
short-term balance sheet elements
Meet ongoing operating and financial needs of the firm, for example:
1) Inventory—To meet production requirements 2) Cash—To meet obligations as they come due.
The objective in managing working capital is to maintain adequate working capital in order to:
1) Meet ongoing operating and financial needs of the firm 2) Not overinvest in net working capital (assets) which provide low returns or increase costs
Working Capital (also called Net Working Capital) formula
Current assets − Current liabilities
Sufficient net working capital must be maintained to avoid the risk of
interrupting operations and the ability to meet current obligations
In a lockbox arrangement, customer payments are
not handled by the firm