Working capital management Essay Example | Topics and Well Written Essays - 1750 words

Working capital management - Essay Example Implementation of an effective working capital management system will certainly assist a company to improve its earnings. Ratio analysis and management of separate elements of working capital are two major aspects of working capital management. Organisations normally give great emphasis on working capital management, because ineffective use of working capital may end up in net losses. Since the management of working capital is crucial for companies irrespective of their size and nature, well structured corporate governance strategies are inevitable for properly dealing with the working capital spending. This paper will discuss the significance of working capital management and various approaches to the management of inventory, receivables, cash, and payables. 1. Management of working capital As discussed above, nowadays firms give specific focus on working capital management because thoughtless short term financing has already caused several corporate failures. As Bokadiya (2011) poi nts out, there are two concepts associated with the management of working capital: gross concept and net concept. The gross concept indicates current assets and this model is known as quantitative aspect of working capital.... stimation is a difficult task for firms in accordance with its nature and size; hence, different firms follow different methods to estimate working capital. Generally, conventional method, operating cycle method, cash cost technique, and balance sheet method are the major approaches adopted for the estimation of working capital. Longenecker, Petty, Palich, and Moore (2009, p.576) describe that the working capital is primarily used to purchase raw materials for production purposes. Through the production process, the raw materials are converted into finished goods and which is then reconverted into cash by the sales process. This whole process is called working capital cycle (ibid). Effective management of working capital assists organisations to deploy current assets and current liabilities efficiently and thereby to maximise short term liquidity. A well structured system of working capital management entails short term decisions generally relating to the next financial period. The p rocess of working capital management mainly involves two steps; forecasting the amount of working capital and determining the sources of working capital. Through proper management of working capital, a firm aims to make optimum level of investment in various working capital assets. This process may also aid companies to assess the optimal mix of short term and long term capital. In addition, effective working capital management can be of great help to choose appropriate means of short term financing. Management of inventory, receivables, cash, and payables are different aspects of working capital management. Inventory management is of great importance in modern business transactions as this process plays a evident role in establishing balance between purchase and sales (Indian Institute of