Working-Capital Policy: The Essence of a Firm
The decisions of financial management are divided into 2 categories i.e. the management of assets (investments) as well as liabilities (sources of funds), both short-term as well as long-term. Unless a firm survives in the short-run, its value cannot be maximized in long-run. Often, the inability to meet the working capital requirements leads to failure of firms. Therefore, efficient working capital policy is indispensable for the survival of a firm.
Generally, working capital is defined as the current assets while the net working capital is described as the current assets minus the current liabilities. Therefore, a working capital policy identifies with the decisions related to level of current assets, means of financing the current assets. However, the working capital management is defined as the decisions as well as the activities undertaken by a firm for efficient management of the components of the current assets. Moreover, short-term financing and current asset management form the two basic components of working capital. It is extremely difficult for a firm to be profitable and efficient if it lacks a sound working capital policy.
Statements related to the cost, risk-bearing capacity and flexibility of short-term debt as opposed to the long-term debt is decided by the type of short-term credit which is actually utilized. The short-term credit refers to liability scheduled to be repaid within a year’s period. Short-term assets normally include advances, loans, inventories, bank balance, cash, debtors and investments. The key components of the current liabilities are bank overdrafts and trade creditors.
Generally, organizations concentrate on issues related to cash, supply chain and accounts payable. However, external factors such as the business and legal environment, or the internal mechanisms such as information systems and organization structure can also have a significant impact on its working capital.
Proper cash flow forecasting is the necessity of efficient working capital management. It should also consider the impact of unanticipated events, losses of a key customer, the action of competitors and effect of unexpected demands. Therefore, contingency plans are essential to offset such events. Secondly, addressing to working capital’s issue on a wider range i.e. taking corporate world as the basis offers a few advantages. The cash generated at a particular location could be used at another location. This can be made possible with the help of well-organized banking channels, access to information, good association between billing and production, internal systems for movement of cash and efficient treasury practices.
Useful procedures for dispute management with regard to the customers would also be helpful in the long run. Moreover, an innovative approach which combines financial and operational skills and a broader view of operations of the company would be valuable in identification and implementation of strategies which enable in generating cash on a short-term basis.
Working capital management remains the most important benchmark for measuring the financial and operational efficiency of a company. Therefore, efforts must be made for improving the working capital position of a company.