Working Capital Management
Author: Jonathon Hardcastle

Financial management decisions are divided into the management
of assets (investments) and liabilities (sources of financing),
in the long-term and the short-term. It is common knowledge that
a firm's value cannot be maximized in the long run unless it
survives the short run. Firms fail most often because they are
unable to meet their working capital needs; consequently, sound
working capital management is a requisite for firm survival.

About 60 percent of a financial manager's time is devoted to
working capital management, and many of the potential employees
in finance-related fields will find out that their first
assignment on the job will involve working capital. For these
reasons, working capital policy and management is an essential
topic of study. In many text books working capital refers to
current assets, and net working capital is defined as current
assets minus current liabilities. Working capital policy refers
to decisions relating to the level of current assets and the way
they are financed, while working capital management refers to
all those decisions and activities a firm undertakes in order
to manage efficiently the elements of current assets.

The term working capital originated with the old Yankee
peddler, who would load up his wagon with goods and then go off
on his route to peddle his wares. The merchandise was called
working capital because it was what he actually sold, or
"turned over", to produce his profits. The wagon and horse were
his fixed assets. He generally owned the horse and wagon, so
they were financed with "equity" capital, but he borrowed the
funds to buy the merchandise. These borrowings were called
working capital loans, and they had to be repaid after each
trip to demonstrate to the bank that the credit was sound. If
the peddler was able to repay the loan, then the bank would
issue another loan, and these were sound banking practices. The
days of the Yankee peddler have long since pasted, but the
importance of working capital remains. Current asset management
and short-term financing are still the two basic elements of
working capital and a daily headache for the financial
managers.

Working capital, sometimes called gross working capital, simply
refers to the firm's total current assets (the short-term ones),
cash, marketable securities, accounts receivable, and inventory.
While long-term financial analysis primarily concerns strategic
planning, working capital management deals with day-to-day
operations. By making sure that production lines do not stop
due to lack of raw materials, that inventories do not build up
because production continues unchanged when sales dip, that
customers pay on time and that enough cash is on hand to make
payments when they are due. Obviously without good working
capital management, no firm can be efficient and profitable.

Statements about the flexibility, cost, and riskiness of
short-term debt versus long-term debt depend, to a large
extent, on the type of short-term credit that actually is used.
Short-term credit is defined as any liability originally
scheduled for payment within one year. There are numerous
sources of short-term funds, such as accruals, accounts payable
(trade credit), bank loans, and commercial paper. The major
elements of current liabilities are trade creditors and bank
overdrafts, and these are further analyzed.


About The Author: Jonathon Hardcastle writes articles for
http://letstalkaboutfinance.com/ - In addition, Jonathon also
writes articles for http://businessworldnow.net/ and
http://yourealestatesource.com/