Need For Adequate Working Capital

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The need and importance of adequate working capital for day to day operations can hardly be underestimated.  Every firm must maintain a sound working capital position otherwise; its business activities may be adversely affected.  The financial manager must see that the firm has sufficient working capital as and when required so that the fixed assets of the firm are optionally used.  The objective of financial management i.e. to maximize the wealth of the shareholder cannot be attained if the operations of the firm are not optimized.  Thus, every firm must have adequate working capital.  It should have neither the excessive working capital nor inadequate working capital.  Both situations are risky and may have dangerous outcome.  The excessive working capital, when the investment in working capital is more than the required level, may result in

a)    Unnecessary accumulation of inventories resulting in waste, theft, damage etc.
b)    Delays in collection of receivables resulting in more liberal credit terms to customers than warranted by the market conditions.
c)    Adverse influence on the performance of the management.

On the other hand, inadequate working capital situation, when the firm does not have sufficient working capital to support its operations, is also not good for the firm.  Such a situation may have following consequences:

i)    The fixed assets may not be optimally used.
ii)    Firm’s growth may stagnate.
iii)    Interruptions in production schedule may occur ultimately resulting in towering of the profit of the firm.
iv)    The firm may not be able to take benefit of an opportunity.
v)    Firm’s goodwill in the market is affected if it is not in a position to meet its liabilities on time.

In view of the above, it can be said that the management of a firm in general and the financial manager in particular, must understand the importance of adequate working capital.  In other words, the working capital level of a firm must be maintained and managed at an appropriate level.  The financial manager must establish (i) a well defined working capital policy at (ii) a self sufficient working capital management system.  While designing the working capital policy, the financial manager should take care of the following aspects.

a)    What should be the level of total and individual current assets in view of the expected sales level?
b)    The financing pattern of the total working capital needs.

The working capital system should be established to take care of management of all aspects of the current assets.  Efforts should be made to establish a built-in internal control system to take note of the level as well as fluctuations in all components of the working capital. 

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