What is working capital management?

Working capital is the operating capital of a business which is used in its day-to-day operations, calculated as the current assets minus the current liabilities. The positive working capital commonly indicates that a company is able to pay off its short-term liabilities almost immediately.

An important objective of the working capital management is improving profitability without exposing liquidity.

For example, the tendency of some manufacturing units holding the current assets (stocks and receivables) beyond the requirement of holding period has the financial implication, as more amount of interest payable on current liabilities for the time taken in converting the current assets into cash. In the other words, saving of financial cost of the business in its operations and ensure that it has sufficient funds to satisfy both maturing short-term liabilities and upcoming operational expenses.

Another important function of working capital management is to appraise the operating and financial performance of an economic activity and determine its efficiency, profitability, liquidity and solvency. Appraisal of Current ratio and quick ratio are the two important parameters of working capital.

Current Ratio: This ratio indicates credit strength of a business by indicating how much of current assets are available for meeting each rupee of liability. Current ratio also shows solvency and adequacy of working capital in a business. It also gives the fair idea of over trading. Any rise in the current ratio shows improved credit strength and fall indicates deteriorating credit strength.  Although, the higher ratio may be good from the point of view of creditors; in the long run very high current ratio may also affect the profitability of the firm.

Quick ratio/Acid test: The objective of Quick ratio/Acid test is to know the level of liquidity position to pay off all current liabilities including Bank Liabilities. The ratio indicates the extent to which current liabilities could be met without relying upon the sale of stock, which means the size of the liquid assets that can be readily converted into cash in relation to the total liability.

Conclusion: A good working capital management will definitely improve the solvency as well as profitability for an organization