1. Meaning of Working Capital
Working capital is the part of the company’s total capital. This capital is required by all the businesses for financing their short-term needs and is a part of current assets. It is the measure of the company’s efficiency to pay its short-term dues as well as manage operational expenses.
2. Understanding Working capital management
Due to the relationships between different components of working capital, it is of utmost importance to manage a company’s working capital. Stock is purchased from suppliers on credit and the final product is sold on credit sometimes too. This generates accounts payables and receivables. The cash collected from the customers is used later to pay off the suppliers. There is clear rotation of funds here. It is very difficult to control the time within which the inventory will be sold and debtors will pay to the company. That is why controlling the rolling of cash and cash equivalents is very important.
3. Components of Working capital management
a. Inventory Management
Inventories basically include the raw materials, WIP products, and finished goods manufactured or bought from the suppliers. Where the company buys excessive stock, it places a heavy burden on the finances. Similarly, if the inventory isn’t available on time, it will lead to the loss of sales.
Therefore, inventory management involves the control of the stock that is manufactured/ bought for sale in the normal course of business.
b. Accounts Receivable
Accounts Receivable refers to the amount that is due when sales take place and is allowed by the buyers to the seller while conducting business on credit. It is an anticipation of the payment that has to be received by the debtors within the time-period allowed for making the payment.
The process of account receivable management requires effective and accurate handling to ensure the collection of accounts receivable in time. As accounts receivables form a major part of the company’s asset, it leads to the generation of cash in-flow for the business.
c. Accounts Payable
Account Payable can aptly be called a short-term debt payable within short periods of time and is treated as a current liability by the entity that has to make the payment. It is the money owed by the businesses to its suppliers for the goods purchased or services consumed.
The accounts payable needs to be managed effectively as it enhances the short term cash flow position of the business. This can be done by deciding on an optimal timing for payments to the supplier.
d. Cash Management
Cash and Cash equivalents is the most important current assets that be managed under working capital management. Being the most liquid form of asset, it has to be effectively and efficiently managed to maintain company’s financial stability ,meet the unexpected expenses and also handle the regular operational expenses on time (such as payroll). Further managing cash rightly also helps to maintain company's’ rating and avoid insolvency.
Here cash includes, both cash and cash equivalents.