Page 216 - DMGT405_FINANCIAL%20MANAGEMENT

Financial Management

Notes 2. To have understanding of the percentage of funds in current accounts: Working capital
represents a sizeable investment for most firms. Normally, 30 to 60% of the firm’s total
assets are tied up in current accounts.
3. Recording time spent managing current accounts: Financial Managers spend much of their
time to the daily internal operations relating to current assets and current liabilities of the
firms. Although estimates vary, managers spent somewhere between on third and two
thirds of their time in managing the working capital.

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Caution The manager should be aware of the relationship between current and fixed assets
and any charges in the percentage of funds in current accounts.

10.3.1 How much Working Capital is Needed

A number of factors need to be included in the analysis, such as the following:
1. Size of the firm: It may be argued that a firm’s size, either in assets or sales will affect its
need for working capital. A small firm may have extra current assets as a cashier against
cash flow disruptions. Small firms have cash inflows from fewer sources than larger firms
and hence are more affected by the failures of a few customers to pay on time. Larger firms
with many sources of funds may need less working capital as compared to total assets on
sales.

2. Activities of firm: If the firm requires to stock large inventory or sell on relatively easy
credit terms, it will have greater needs for working capital than firms providing services
or only having cash sales.

3. Availability of credit: A firm with readily available credit from banks will be able to plan
for less working capital than a firm without such credit.
4. Attitude towards profits: All funds have a cost; a relatively large amount of current assets
tends to reduce a firm’s profit. Some firms want extra working capital and are willing to
suffer small costs. Other firms maintain an absolute minimum of working capital to gain
the full profits from operation.
5. Attitude towards risk: The greater the amount of working capital particularly cash and
marketable securities the lower the risk of liquidity problems. Firms that do not wish to
incur even slight risks of liquidity problem may like to keep extra cash. Other firms accept
the risks to earn profits and may not even keep adequate cash to pay bills always on time.

Did u know? Most firms seek to maintain sufficient working capital to meet their needs for
liquidity without tying up unnecessary funds.

10.3.2 Forecasting Working Capital Needs

The following are some of the methods used in practice:
1. Current assets holding period: To estimate working capital requirements on the basis of
average holding period of current assets and relating them to cost based on company
experience in the previous year.
2. Ratio of sales: To estimate working capital requirements as a ratio of sales on the
assumption that current assets charge with sales. This can be done through statistical

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