Page 39 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes 1. Cash
2. Marketable Securities
3. Accounts Receivable
4. Inventory

5. Fixed Assets

Notes As we go from the top of the list to the bottom, the liquidity decreases. However, as
we go from top to bottom, the profitability increases.
In other words, the most profitable investment for company is normally in its fixed assets; the
least profitable investment is cash.

Self Assessment

State whether the following statements are true or false:
17. There is a trade-off between liquidity and profitability.

18. Profitability means having enough money in the form of cash, or near-cash assets, to meet
your financial obligations.
19. Liquidity is a measure of the amount by which a company’s revenues exceed its relevant
expenses.
20. The most profitable investment for company is normally in its fixed assets; the least
profitable investment is cash.
2.6 Summary

 The need for working capital (WC) arises from the cash/operating cycle of a firm.
 It refers to the length of time required to complete the following sequence of events:
conversion of cash into inventory, inventory into receivables and receivables into cash.
 The operating cycle creates the need for working capital and its length in terms of time-span
required to complete the cycle is the major determinant of the firm’s working capital needs.

 Working capital requirements are determined by a variety of factors.
 These factors, however, affect different enterprises differently.
 In general, the factors relevant for proper assessment of the quantum of working capital
required are: general nature of business, production cycle, business cycle, production
policy, credit policy, growth and expansion, availability of raw materials, profit-level,
level of taxes, dividend policy, depreciation policy, price level changes and operating
efficiency.
 Manufacturing and trading enterprises require fairly large amounts of working capital to
maintain a sufficient amount of cash, inventories and book debts to support their production
and sales activity.

 Service enterprises and hotels, restaurants and eating houses need to carry less WC.
 The longer is the production cycle, the larger is the WC needed or vice versa.

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