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Workingcapital Management

Essay by   •  September 27, 2011  •  Essay  •  1,143 Words (5 Pages)  •  1,249 Views

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3.1.2 NATURE OF WORKING CAPITAL

EXCESSIVE AND INADEQUATE WORKING CAPITAL: A business enterprise should maintain adequate working capital according to the needs of its business of its business operations. The amount of working capital should neither be excessive nor adequate. If the working capital is excess of its requirements it means idle funds adding to the cost of capital is short of its requirements, it will result in production interruptions and reduction of sales and, in turn, will affect the profitability of the business adversely.

3.1.3 DEFECIENCIES OF EXCESSIVE WORKING CAPITAL

* EXCESSIVE INVENTORY: Excessive working capital results in unnecessary accumulation of large inventory. It increases the chances of misuse, waste, theft etc.

* EXCESSIVE DEBTORS: Excessive working capital will result in liberal credit policy which, in turn, will result in higher amount tied up in debtors and higher incidence of bad debts.

* ADVERSE EFFECT ON PROFITABILITY: Excessive working capital means idle funds in the business which adds to the cost of capital but earns no profits for the firm. Hence it has a bad effect on profitability of the firm.

* INEFFECIENCY OF MANAGEMENT: Management becomes careless due to excessive resources at their command. It results in laxity of control on epenses and cash resources.

3.1.4 DEFECIENCIES OF INADEQUATE WORKING CAPITAL

* DIFFICULTY IN AVALIABILITY OF RAW-MATERIAL: Inadequacy of working capital results in non-payment of creditors on time. As a result the credit purchase of goods on favorable terms becomes increasingly difficult. Also, the firm cannot avail the cash.

* FULL UTILISATION OF FIXED ASSETS NOT POSSIBLE: Due to the frequent interruption in supply of raw materials and paucity of stock, the firm can't make full utilization of its machines etc.

* DIFFICULTY IN THE MAINTAINENCE OF MACHINERY: Due to the shortage of working capital, machines are not cared and maintained properly which results in the closure of production of on many occasions.

* DECRAESE IN CREDIT RATING: Because of inadequacy of working capital, firm is unable to pay its short term obligations on time. It decays the firm's relation with its bankers and it becomes difficult for the firm to borrow in case of need.

3.1.5 ADVANTAGES OF ADEQUATE WORKING CAPITAL

* AVAILIABILTY OF RAW MATERIAL REGULARLY: Adequacy of working capital makes it possible for a firm to pay the suppliers of raw material in time. As a result it will continue to receive regular supplies of raw materials and thus there will be no disruption in production process.

* FULL UTILISATION OF FIXED ASSETS: Adequacy of working capital makes it possible for a firm to utilize its fixed assets fully and continuously. For eg. , if there is inadequate stock of raw material, the machines will not be utilized in full and their productivity will be reduced.

* CASH DICOUNT: A firm having the adequate working capital can avail the cash discount by purchasing the goods for cash or by making the payment before the due date.

* MEETING UNSEEN CONTINGENCIES: Adequacy of working capital enables a company to meet the unseen contingencies successfully.

3.1.6 NEED OF WORKING CAPITAL

Alongwith the fixed capital almost every business requires working capital though the extent of working capital requirements differ in different businesses. Working capital is needed for running the day-to-day business activities. When a business is started, working capital is needed for purchasing raw material. The raw material is then converted into finished goods by incurring some additional costs on it. Now goods sre sold. Sales do not convert into cash instantly

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