What are the implications of management decisions on working capital?

I prefer to leave answers to Experts. Thanks for Your kind Invitation.

Working capital management is a managerial accounting strategy focusing on maintaining efficient levels of both components of working capital, current assets and current liabilities, in respect to each other. Working capital management ensures a company has sufficient cash flow in order to meet its short-term debt obligations and operating expenses.

Implementing an effective working capital management system is an excellent way for many companies to improve their earnings. The two main aspects of working capital management are ratio analysis and management of individual components of working capital.

A few key performance ratios of a working capital management system are the working capital ratio, inventory turnover and the collection ratio. Ratio analysis will lead management to identify areas of focus such as inventory management, cash management, accounts receivable and payable management.

While managing the working capital, two characteristics of current assets should be kept in mind viz. (i) short life span, and (ii) swift transformation into other form of current asset. Each constituent of current asset has comparatively very short life span. Investment remains in a particular form of current asset for a short period. The life span of current assets depends upon the time required in the activities of procurement; production, sales and collection and degree of synchronisation among them. A very short life span of current assets results into swift transformation into other form of current assets for a running business. These characteristics have certain implications:

1.       Decision regarding management of the working capital has to be taken frequently and on a repeat basis.

2.       The various components of the working capital are closely related and mismanagement of any one component adversely affects the other components too.

3.       The difference between the present value and the book value of profit is not significant.

The working capital has the following components, which are in several forms of current assets:

Stock of Cash

Stock of Raw Material

Stock of Finished Goods

Value of Debtors

Miscellaneous current assets like short term investment loans & advances

The working capital needs of a business are influenced by numerous factors. The important ones are discussed in brief as given below:

1.       Nature of Enterprise

The nature and the working capital requirements of an enterprise are interlinked. While a manufacturing industry has a long cycle of operation of the working capital, the same would be short in an enterprise involved in providing services. The amount required also varies as per the nature; an enterprise involved in production would require more working capital than a service sector enterprise.

2.       Manufacturing/Production

Policy Each enterprise in the manufacturing sector has its own production policy, some follow the policy of uniform production even if the demand varies from time to time, and others may follow the principle of 'demand-based production' in which production is based on the demand during that particular phase of time. Accordingly, the working capital requirements vary for both of them.

3.       Operations

The requirement of working capital fluctuates for seasonal business. The working capital needs of such businesses may increase considerably during the busy season and decrease during the slack season. Ice creams and cold drinks have a great demand during summers, while in winters the sales are negligible.

4.       Market Condition

If there is high competition in the chosen product category, then one shall need to offer sops like credit, immediate delivery of goods etc. for which the working capital requirement will be high. Otherwise, if there is no competition or less competition in the market then the working capital requirements will be low.

5.       Availability of Raw Material

If raw material is readily available then one need not maintain a large stock of the same, thereby reducing the working capital investment in raw material stock. On the other hand, if raw material is not readily available then a large inventory/stock needs to be maintained, thereby calling for substantial investment in the same.

6.       Growth and Expansion

Growth and expansion in the volume of business results in enhancement of the working capital requirement. As business grows and expands, it needs a larger amount of working capital. Normally, the need for increased working capital funds precedes growth in business activities.

7.       Price Level Changes

Generally, rising price level requires a higher investment in the working capital. With increasing prices, the same level of current assets needs enhanced investment.

8.       Manufacturing Cycle

The manufacturing cycle starts with the purchase of raw material and is completed with the production of finished goods. If the manufacturing cycle involves a longer period, the need for working capital would be more.

 Decision regarding management of the working capital has to be taken frequently and on a repeat basis

It is like asking do you budget for working capital and then do strategy or do you strategise first and the put a budget in place to support the strategy.

Strategy about what decisions need to be in the medium term must always come first. 

Of the main duties of any financial maintain appropriate liquidity km Foundation to ensure that they fulfill their obligation on time. And of the main requirements to achieve this province on the occasion of the traded good-quality assets amount end, and in particular the city accounts and goods, control of the creditor and monitored and to make sure that there is a difference fit between them and the current assets within the limit that ensures no exposure calculations Foundation for the risk of failure to meet its obligations in the short term primarily

I fully agree with mr. Shameer Nazir's quality, constructive & excellent submission that sums it up, its really helpful.

Thanx for the invitation

Working capital management or short-term financial management is a significant facet of financial management. It is important due to 2 reasons:

• Investment in current assets represents a substantial portion of total investment
• Investment in current assets and the level of current liabilities have to be geared quickly to changes in sales.

Working capital involves activities such as arranging short-term finance, negotiating favourable credit terms, controlling the movement of cash, administrating accounts receivables, and monitoring the investment in inventories also take a great deal of time.

Factors influencing working capital requirements

• Nature of business – This is one of the primary factors influencing the working capital requirements of a firm. For instance, a service firm like a hotel has a short operating cycle since it sells mostly on a cash basis and has a lower working capital requirement. A manufacturing firm, on the other hand, has a longer operating cycle and invests more in its current assets. It thus has a greater working capital requirement.
• Seasonality of operations – Some firms’ products sell only during particular seasons. For instance, air conditioners sell more during the summer than in the winter. Such firms have greater working capital requirements during peak seasons and lower requirements during other seasons. Firms whose sales are not affected by seasons have stable working capital requirements.
• Market conditions – The level of competition existing in the market also influences working capital requirement. When competition is high, the company should have enough inventory of finished goods to meet a certain level of demand. Otherwise, customers are highly likely to switch over to competitor’s products. It thus has greater working capital needs. When competition is low, but demand for the product is high, the firm can afford to have a smaller inventory and would consequently require lesser working capital.
• Supply conditions – If supply of raw material and spares is timely and adequate, the firm can get by with a comparatively low inventory level. If supply is scarce and unpredictable or available during particular seasons, the firm will have to obtain raw material when it is available. It would thus need more working capital to carry a large inventory and conduct operations all year round.

Current Assets

Current assets of a firm include: –

1. Cash balances
2. Accounts receivables
3. Inventories of 
   • Raw material 
   • Work-in-progress
   • Finished goods

The two major characteristics of current assets are: -

• They have a short life span. Cash balances are held only for a week or so; accounts receivables typically are held for a duration of 30-60 days and inventories may be held for 30-100 days.
• They are rapidly transformed into other asset forms. Cash is utilised to purchase raw material. Raw material is converted to work-in-progress, which in turn is converted to finished goods. Finished goods are sold for cash or credit, which creates accounts receivables. Accounts receivables are finally realised in cash.

Based on these characteristics of current assets, the following implications arise–

1. Working capital management involves making frequent decisions. 
2. The difference between profit and present value is insignificant. 
3. Since the various components of working capital closely interact with each other, decisions pertaining to one component must be taken after giving consideration to the effect on other components. For instance, if the inventory of finished goods is high, the firm may have to offer generous credit terms. 

Working capital (abbreviated WC) is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Gross working capital equals to current assets. Working capital is calculated as current assets minus current liabilities.[1] If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit.

A company can be endowed with assets and profitability but short of liquidity if its assets cannot readily be converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable, and cash.

Working capital is the difference between the current assets (except cash) and the current liabilities.

The basic calculation of the working capital is done on the basis of the gross current assets of the firm.

{\\displaystyle {\\text{Working Capital}}={\\text{CURRENT ASSETS}}-{\\text{CURRENT LIABILITIES}}}

Inputs[edit]

Current assets and current liabilities include three accounts which are of special importance. These accounts represent the areas of the business where managers have the most direct impact:

• accounts receivable (current asset)
• inventory (current assets), and
• accounts payable (current liability)

The current portion of debt (payable within 12 months) is critical, because it represents a short-term claim to current assets and is often secured by long-term assets. Common types of short-term debt are bank loans and lines of credit.

An increase in net working capital indicates that the business has either increased current assets (that it has increased its receivables, or other current assets) or has decreased current liabilities—for example has paid off some short-term creditors, or a combination of both.

Decisions relating to working capital and short-term financing are referred to as working capital management. These involve managing the relationship between a firm's short-term assets and its short-term liabilities. The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses.

A managerial accounting strategy focusing on maintaining efficient levels of both components of working capital, current assets and current liabilities, in respect to each other. Working capital management ensures a company has sufficient cash flow in order to meet its short-term debt obligations and operating expenses.

Decision criteria[edit]

By definition, working capital management entails short-term decisions—generally, relating to the next one-year period—which are "reversible". These decisions are therefore not taken on the same basis as capital-investment decisions (NPV or related, as above); rather, they will be based on cash flows, or profitability, or both.

• One measure of cash flow is provided by the cash conversion cycle—the net number of days from the outlay of cash for raw material to receiving payment from the customer. As a management tool, this metric makes explicit the inter-relatedness of decisions relating to inventories, accounts receivable and payable, and cash. Because this number effectively corresponds to the time that the firm's cash is tied up in operations and unavailable for other activities, management generally aims at a low net count.
• In this context, the most useful measure of profitability is return on capital (ROC). The result is shown as a percentage, determined by dividing relevant income for the 12 months by capital employed; return on equity (ROE) shows this result for the firm's shareholders. Firm value is enhanced when, and if, the return on capital, which results from working-capital management, exceeds the cost of capital, which results from capital investment decisions as above. ROC measures are therefore useful as a management tool, in that they link short-term policy with long-term decision making. See economic value added (EVA).
• Credit policy of the firm: Another factor affecting working capital management is credit policy of the firm. It includes buying of raw material and selling of finished goods either in cash or on credit. This affects the cash conversion cycle.

Management of working capital[edit]

Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital. The policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short-term financing, such that cash flows and returns are acceptable.

• Cash management. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.
• Inventory management. Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials—and minimizes reordering costs—and hence increases cash flow. Besides this, the lead times in production should be lowered to reduce Work in Process (WIP) and similarly, the Finished Goods should be kept on as low level as possible to avoid over production—see Supply chain management; Just In Time (JIT); Economic order quantity (EOQ); Economic quantity
• Debtors management. Identify the appropriate credit policy, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances.
• Short-term financing. Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors to cash" through "factoring".

I fully endorse answer given by Mr. Shameer Nazir Madari. Thanks

Thanks for the invite ............................ agreed with Mr. Yasser answers

Agree with expert ansewrs above