All businesses need cash to survive
• Cash is needed to:
– Invest in fixed assets
– Pay suppliers and employees
– Fund overheads and other fixed costs
– Pay tax due to the Government
Managing working capital effectively is, therefore, a
vital part of making sure the business has enough cash
Managing Current Assets and Liabilities is nothing new to us. We practice it everyday without us notice it. Let us assume you want to reward your self by buying a new car. What are the things you consider? Shall I buy it paying by cash or installment basis? If I pay it by cash, a large amount of my savings will go to that car sacrificing other things I want to buy also. But if I pay it by installment, I have to consider the end of the payment total amount against cash price. I also have to consider whether I have enough salary to pay it by monthly for a period of time. I also have to consider whether I can continue receiving that particular amount until the duration of my monthly payment. This paper will try to present a good picture of how to manage our current assets and liabilities.
To begin with, Current assets is defined as company owned resources with a considerable value that is expected to be converted into cash in a period of less than one year in the normal course of business. These includes cash, inventory, accounts receivable, prepaid expenses, and short-term marketable securities and other assets that can readily be converted into cash within one year. On the other hand, current liabilities are company’s debts and loans or obligations that must be paid back to the lender within one year or less. This includes accounts payable , accrued expenses, and current portion of long term debts or loans. And if you compare the totals of these two groups of items, the difference is called the company’s working capital. What has working capital management has to do with these two groups of items? Working capital is the cash needed to
pay for the daytoday operation of the
Danger of Overtrading
Overtrading happens when a
business tries to do too much, too quickly with too little long-term capital
Overtrading represents an imbalance between the
orders a business accepts and the means it has to fulfill
• Overtrading happens when a business takes on
customer orders, but does not have enough current
assets, or working capital, to meet these demands
• Overtrading is particularly common in young, rapidly
expanding businesses. It can be extremely serious,
even fatal to the business
The two main objectives of working capital management is to increase the profitability of a company and to make sure that it has enough cash to pay or meet its short-term obligations as the due dates of these loans comes near. Working capital of a company can be classified as Aggressive, Moderate or Conservative. An Aggressive working capital means a company chooses to operate its daily business activities by providing lower level of inventory, accounts receivable, and cash. It may increase profitability because less cash is invested into its inventory,. However, it will also increase the risk of possible cash shortages or running out of inventories that may result in less revenues. A Conservative working capital means maintaining a larger cash balance, and bringing the cash surplus into a more profitable business activities; giving flexible terms for credit customers; or having high level of inventories. However, there is less profit in this class. A Moderate class means it is between the Aggressive and the Conservative class.
The two main objectives of working capital management are to increase the profitability of a company and to ensure that it has sufficient liquidity to meet short-term obligations as they fall due and so continue in business (Pass and Pike 1984).
The heart of a successful business organization depends on how...
References:  Afza, T. and M. S. Nazir, (2007). Working Capital Management Policies of Firms: Empirical
Evidence from Pakistan
 Afza, T. and M. S. Nazir, (2008). Working Capital Approaches and Firm’s Returns. Pakistan
Journal of Commerce and Social Sciences
 Baltagi, B. H. (2001). Econometric Analysis of Panel Data. 2nd Edition, John Wiley & Sons.
 Blinder, A. S. and L. Macinni, (1991). Taking Stock: A critical Assessment of Recent Research
 Czyzewski, A.B., and D.W. Hicks, (1992). Hold Onto Your Cash. Management Accounting.
 Deloof, M. (2003). Does Working Capital Management Affects profitability of Belgian Firms?
Journal of Business Finance & Accounting
 Economic Survey of Pakistan, (2006-07). Finance Division, Government of Pakistan.
 Eljelly, M.A. (2004). Liquidity – Profitability Tradeoff: An empirical investigation in an
 Filbeck, G. and T. M. Krueger, (2005). An Analysis of Working Capital Management results
 Garcia-Teruel, P.J. and Martinez-Solano, P. (2007). Effects of Working Capital Management
on SME Profitability
International Research Journal of Finance and Economics - Issue 47 (2010) 162
 Gitman, L.J
 Hausman, J.A. (1978), Specification Tests in Econometrics. Econometrica. 46, 1251-71.
 Jose, M. L., C. Lancaster, and J. L. Stevens, (1996). Corporate Returns and Cash Conversion
 Kargar, J. and R. A. Blumenthal, (1994). Leverage Impact of Working Capital in Small
 Lazaridis, I. and D. Tryfonidis, (2006). Relationship between Working Capital Management
and Profitability of Listed Companies in the Athens Stock Exchange
 Mukhopadhyay, D. (2004). Working Capital Management in Heavy Engineering Firms—A
 Padachi, K. (2006). Trends in Working Capital Management and its Impact on Firms’
Performance: An Analysis of Mauritian Small Manufacturing Firms
 Raheman, A. and M. Nasr, (2007). Working Capital Management and Profitability – Case of
 Samiloglu, F. and K. Demirgunes, (2008). The Effects of Working Capital Management on
Firm Profitability: Evidence from Turkey
 Shah, A. and A. Sana, (2006). Impact of Working Capital Management on the Profitability of
Oil and Gas Sector of Pakistan
 Shin, H., and L. Soenen, (1998). Efficiency of Working Capital and Corporate Profitability.
 Smith, M. Beaumont, E. Begemann, (1997). Measuring Association between Working Capital
and return on Investment
 Soenen, L.A. (1993). Cash Conversion Cycle and Corporate Profitability. Journal of Cash
 Uyar, A. (2009). The Relationship of Cash Conversion Cycle with Firm Size and Profitability:
An Empirical Investigation in Turkey
 Van Horne, J. C. and J. M. Wachowicz, (2000). Fundamentals of Financial Management.
 Vishnani, S. and K.S. Bhupesh, (2007). Impact of Working Capital Management Policies on
Corporate Performance- An Empirical Study
 Wang, Y.J. (2002). Liquidity Management, Operating Performance, and Corporate Value:
Evidence from Japan and Taiwan
Leach, J.C., and Ronald W. Melicher. Entrepreneurial Finance. 2nd ed. Mason, OH: Thomson South-Western, 2006.
Shapiro, Alan C
Please join StudyMode to read the full document