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Monday, September 12, 2011

Working Capital Management in Finance

Working Capital Management is yet another important short-term concept. Working Capital, as the name suggests is that capital which is required to run the day to day activities of a firm. These include the day to day operations such as buying of raw materials, maintenance of stock, producing the goods and selling these products.

Net working capital = current assets – current liabilities

Net operating working capital = current assets – non-interest bearing current liabilities

Equity working capital = current assets – current liabilities – long-term debt

All these activities require money. For some expenses, credit is provided and for some expenses, cash is to be paid without any delays. All these expenses have to be met for selling the goods at hand. Only after the goods have been sold, that the company can realize revenues and eventually profits. Until, that time, the company will have to bear the expenses.

The above mentioned raw materials, inventory, goods-in-progress, debtors and finished goods are all current assets. These current assets are meant to be realized within a maximum time of one year. Here cash flows of a company are the deciding factor in the working capital.

Working capital Management and Requirements differ from industry to industry and from company to company. Keeping the industry norms as a standard, a company will have to decide its own working capital range depending upon its scale of operations.

For industries where the concentration is more in producing goods, the investment in long-term assets such as plant and machinery is much greater in comparison to the current assets such as raw materials, creditors or debtors and other current assets and liabilities.

In companies which are into retail businesses, the investment in current assets and liabilities is much greater in comparison to the long-term assets such as land and buildings.

Firms on the other hand will also have to maintain a certain amount of cash on a daily basis. The degree of uncertainty in the future requirement of cash is one of the reasons for this.

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