Working Capital

Working capital refers to the accessible funds for day-to-day business operations. It signifies the financial health of the organisation and its ability to meet short-term liabilities.
The two main components of working capital are current assets and current liabilities. Current assets include cash, inventory, accounts receivables, etc., while current liabilities encompass short-term debts, accounts payable, taxes, etc.
The formula to calculate working capital is: Working Capital = Current Assets - Current Liabilities.
Positive working capital indicates that a business has sufficient funds to cover its short-term debts and operational expenses.
Negative working capital implies that a company is facing a shortage of funds to manage daily operations and needs immediate financing.

Management of Working Capital

Efficient working capital management involves the balancing of current assets and current liabilities, ensuring liquidity, and maintaining operational efficiency.
The two prevalent working capital management strategies are the conservative strategy and the aggressive strategy. A conservative strategy entails maintaining high levels of current assets, while an aggressive strategy involves keeping low levels of current assets.
Cash management is a critical aspect of working capital management. It involves managing the cash inflows and outflows to ensure sufficient liquidity for daily operations.
Inventory management focuses on balancing the cost of holding inventory against the cost of running out of stock. A high inventory level might lead to high holding costs, while a low level may interrupt production or sales.
Debtors management refers to the strategic collection of accounts receivables to minimise the risk of bad debts. Credit policies need careful formulation and implementation to ensure timely collection of dues.
Efficient working capital management ensures business solvency, boosts profitability, and enhances the company’s capacity to face financial crises and market competition.

Internal sources of working capital include profits from business operations, tightened credit policies, and improved inventory management.
External sources of working capital include short-term loans such as overdrafts, trade credit, and factoring services which involve selling receivables at a discount to get immediate cash.
Choosing the appropriate source of working capital depends on factors such as cost, risk, economic conditions, and the nature of the business. For instance, an overdraft may be an efficient short-term solution for seasonal businesses, while factoring services might be more beneficial for firms with high receivable days.
It’s worth mentioning that excessive reliance on external sources might increase the business’s risk exposure due to interest payments and contingency of cash flows. Thus, a balance between internal and external sources is often the most suitable approach.