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Scope of Working Capital Management-Trade off b/w Liquidity & Profitability & Investment & Financing
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  1. Management of Working Capital By Heena Malhotra

  2. MANAGEMENT OF WORKING CAPITAL The working capital of an entity can be termed as for example, life blood if an entity is compared with a living body; lubricant/ fuel if is an entity is compared with an engine. Working capital is required for smooth functioning of the business of an entity as lack of this may interrupt the ordinary activities. Hence, the working capital needs adequate attention and efficient management. When we talk about the management it involves 3 Es i.e. Economy, Efficiency and Effectiveness and all these three are required for the working capital management. The scope of working capital management can be grouped into two broad areas (i) Profitability and Liquidity and (i) Investment and Financing Decision Scope of Working Capital Management Liquidity and Profitablility Investment and Financing

  3. Liquidity and Profitability o For uninterrupted and smooth functioning of the day to day business of an entity it is important to maintain liquidity of funds evenly. o As we have already learnt in previous chapters that each rupee of capital bears some cost. So, while maintaining liquidity the cost aspect needs to be borne in mind. o Unnecessary tying up of funds in idle assets not only reduces the liquidity but also reducing the opportunity to earn better return from a productive asset. o Hence, a trade-off is required between the liquidity and profitability which increases the profitability without disturbing the day to day functioning. O This requires 3Es as discussed above i.e. economy in financing, efficiency in utilisation and effectiveness in achieving the intended objectives. By Heena Malhotra

  4. The trade-off between the components of working capital can be summarised as follows: Advantages of Working of higher side Trade-off (between Advantages of lower side (Liquidity) Component Capital (Profitability) Profitability and Liquidity) Inventory Fewer stock- Use techniques like Lower inventory outs increase the EOQ JIT etc. to carry requires less capital but profitability optimum level of endangered stock-out inventory. and loss of goodwill. Receivables Higher Credit period Evaluate the credit Cash sales provide attract customers policy, use the and increase revenue services of debt management (factoring) agencies. liquidity but fails to boost sales and revenue By Heena Malhotra

  5. Pre-payment Reduces uncertainty Cost-benefit analysis Improves or of expenses and profitable required maintains liquidity in inflationary environment Cash and Cash Payables are Cash budgets equivalents honoured in time, and other cash management Cash can be invested in some other investment avenues improves the goodwill and helpful techniques can be in getting futureused discounts. Payables and Capital can be Expenses Evaluate the creditPayables are used in some other policy and related honoured in time, investment avenues |cost. improves the goodwill and helpful in getting future discounts By Heena Malhotra

  6. Scope of Working Capital Management Liquidity and Profitablility Investment and Financing By Heena Malhotra

  7. Investment and Financing o Working capital policy is a function of two decisions, first, investment in working capital and the second is financing of the investment. o Investment in working capital is concerned with the level of investment in the current assets. It gives the answer of 'How much' fund to be tied in to achieve the organisation objectives (i.e. Effectiveness of fund) o Financing decision concerned with the arrangement of funds to finance the working capital. It gives the answer 'Where from fund to be sourced' at lowest cost as possible (i.e. Economy) By Heena Malhotra

  8. Approaches of working capital investment Aggressive Moderate Conservative By Heena Malhotra

  9. (a) Aggressive o Here investment in working capital is kept at minimal investment in current assets which means the entity does hold lower level of inventory, follow strict credit policy, keeps less cash balance etc. O The advantage of this approach is that lower level of fund is tied in the working capital which results in lower financial costs but the flip side could be that the organisation could not grow which leads to lower utilisation of fixed assets and long term debts. In the long run firm stay behind the competitors By Heena Malhotra

  10. (b) Conservative: o In this approach of organisation use to invest high capital in current assets. Organisations use to keep inventory level higher, follows liberal credit policies, and cash balance as high as to meet any current liabilities immediately. O The advantage of this approach are higher sales volume, increased demand due to liberal credit policy and increase goodwill among the suppliers due to payment in short time. o The disadvantages are increase cost of capital, higher risk of bad debts, shortage of liquidity in long run to longer operating cycles. By Heena Malhotra

  11. Conservative policy Averag e policy Aggressive policy Fixed asset level Output By Heena Malhotra