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Unit 10: Working Capital Management

preceding year. Management has no discretion in regard to payment of taxes; in some Notes
cases non-payment may invite penal action. There is, however, wide scope to reduce the
tax liability through proper tax planning.
11. Dividend Policy: Payment of dividend utilizes cash while retaining profit acts as a source
of working capital. Thus working capital gets affected by dividend policies.

12. Operating Efficiency: Efficient and co-ordinated utilization of capital reduces the amount
required to be invested in working capital.
13. Price Level Charges: Inflationary trends in the economy necessitate more working capital
to maintain the same level of activity.
14. Depreciation Policy: Depreciation charges do not involve any cash outflow. The effect of
depreciation policy on working capital is, therefore, indirect. In the first place, depreciation
affects the tax liability and retention of profits and on dividend.
15. Vagaries in the Availability of Raw Materials: The availability or otherwise of certain
raw materials on a continuous basis without interruption would sometimes effect the
requirement of working capital. There may be some materials, which cannot be procured
easily either because their sources are few or they are irregular. To sustain smooth
production, therefore, the form may be compelled to purchase and stock them far in excess
of genuine production needs. This will result in an excessive inventory of such materials.

Self Assessment
Fill in the blanks:
1. The total of investments in all current assets is known as …………..working capital.

2. The effect of depreciation policy on working capital is ……………..

10.2 Importance of Adequate Working Capital and Optimum
Working Capital

A concern needs funds for its day-to-day running. Adequacy or inadequacy of these funds would
determine the efficiency with which the daily business may be carried on. A large amount of
working capital would mean that the company has idle funds. Such firms have a cost. The
company has to pay large amount as interest on such funds. This results in over-capitalization.
Over-capitalization implies that the company has too large funds for its requirements, resulting
in a low rate of return a situation, which implies a less than optimal use of resources.
If the firm has inadequate working capital, it is said to be under-capitalized. Such a firm runs the
risk of insolvency. This is because paucity of working capital may lead to a situation where the
firm may not be able to meet its liabilities. It is interesting to note that many firms that are
otherwise prosperous (having good demand for their products and enjoying profitable marketing
conditions) may fail because of lack of liquid resources.
A question may arise as to what is the amount of optimum working capital for a firm.

It cannot be overemphasized that optimum working capital can be determined only with
reference to the particular circumstances of a specific situation. Thus, in a company where the
inventories are easily saleable and the sundry debtors are as good as liquid cash, the current
rates may be lower than 2 and yet the firm may be sound. An optimum working capital ratio is
dependent upon the business situation as such and the nature and composition of various current
assets.

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