Financial Management MANAGEMENT OF WORKING CAPITAL 1 What
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Financial Management MANAGEMENT OF WORKING CAPITAL 1
What is Working Capital? Working capital typically means net current assets which are available for day-to-day operating activities. It normally includes q inventories, q receivables, q cash (and cash equivalents), less q payables. Working capital = inventory + receivables + cash – payables 2
Investment in Working Capital? Working capital needs financing, just as does the investment in machines. Investment Fixed Assets Earn Profits Investment in working capital does not directly earn profits. If this were the only consideration, then it would be better to invest all the finance available in fixed assets and to keep working capital to an absolute minimum Working capital = receivables + cash + inventory – payables 3
Working Capital Trade-off Profitability Liquidity Optimum Level of Working Capital The company therefore faces a trade-off between profitability and liquidity, and it is up to the financial manager to decide on the optimal level of working capital and to ensure that it is managed properly 4
What is Working Capital? On the other hand, all companies need some working capital in order to keep the business running • Customers should be allowed to buy on credit, otherwise company would lose business to Customer competitors Inventory Cash • Company’s need to carry inventories of finished goods in order to be able to fulfil demand • they need to have a short-term cash balance in order to be able to pay their bills 5
Financing of Working Capital Long Term Financing Short Term Financing Equity shares or Long-term borrowings Overdraft Delaying payments to creditors Expensive and less risky as it is repayable on an agreed period Cheaper and risky as it is repayable on demand Long Term Assets – Fixed Assets Short Term Assets Inventories 6
Financing of Working Capital Permanent Working Capital Temporary Working Capital Remains Fixed Day-to-day fluctuation of Working Capital Long Term Short Term Finance Through Long Term Financing Finance Through Short Term Financing 7
