The goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability 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.
The cycle starts from the acquisition of raw material to its conversion to cash . It is not easy; it is as good as circulating 5 balls with two hands without dropping a single one. If following 6 points can be managed, this operating cycle can be management well.
1. It means raw material should be present on the requirement and it should not be a cause to stoppages of production.
2. All other requirements of production should be in place before time.
3. The finished goods should be sold as early as possible once they are produced and inventoried.
4. The accounts receivable should be collected on time.
5. Accounts payable should be paid when due without any delay.
6. Cash should be available as and when required along with some cushion.
The difference between total current assets and total current liabilities is termed as Net Working Capital. Current Assets are those assets that in the ordinary course of business can be or will be turned into cash within a period of not exceeding one year. Examples of current assets are cash, cash at bank, stock in trade, sundry debtors.
Current liabilities are those liabilities intended at their inception to be paid in an ordinary course of business within a period of not exceeding one year. The examples of current liabilities are sundry creditors for purchases of raw materials, bills payable, cash credit or packing credit finance from banks, bank overdrafts etc.
The working capital cycle refers to the period that a business enterprise takes in converting cash back to cash.
As an example, an exporter uses cash to acquire an inventory of materials that is converted into semi-finished goods and then into finished goods. When finished goods are exported to imports on credit, accounts receivable are generated. When the proceeds come from abroad, the exporter gets the cash back. At this stage, one operating cycle is completed. Thus a circle from cash-bac-to-cash is called the working capital cycle. This concept is also known as ‘pipe line theory’.
When the period of the operating cycle is more, the exporter requires more finance from the bank. If this cycle is shorter in nature, then finance required