Getting to know working capital management better

Getting to know working capital management better

How does a company measure liquidity, operational efficiency, and its overall financial health? Working capital includes both current assets and current liabilities and is calculated as current assets vs. current liabilities. Between the rating 1.2 and 2.0, is what a working capital ratio is considered to be safe.

Below 1.0: Negative working capital ratio.

Above 2.0: Current assets are not used effectively.

What is Working Capital Management?

A company develops some strategies for the proper utilisation of the two components of working capital i.e. current assets and current liabilities which is known as Working Capital Management. The main objective of WCM is to make sure that sufficient cash is available to meet the company’s short-term requirements. A company with proper working capital management can gradually increase its earnings and profitability and can also help in the proper and smooth functioning of business operations.

Components of Working Capital Management (WCM):

The financial health of a company can be measured by the working capital ratio indicate the liquidity of the company and how well it can meet its financial obligations. A negative working capital ratio can hamper the growth of the firm. On the other hand, a higher working capital ratio indicates that assets are not being used efficiently and effectively. Maintaining an effective working capital ratio in a direct indicator of help assess the company financial health.

The next component of WCM is inventory management. Production has to be to increased or decreased according to the consumption behaviour of the consumers also keeping in mind the logistics time flow. Therefore products sold, in-stock and replenished with the help of inventory turnover ratios should also be monitored.

Though WCN is not the only indicator an investor should monitor, it acts as an effective toll to judge the financial health of the company in times to come. Other assessments such as ‘management of debtors’, ‘credit policies’, ‘collection ratio’ (the average number of days a company takes to infuse cash) would help analyse a company’s’ financial outlook better.

In short, every company should have a proper system for Working Capital Management monitoring flow chart in place to assist the functioning of the firm and also to help it to grow.