Working capital is the amount of funds necessary for the cost of operating the enterprise. Working capital is backbone of enterprise, as it provides number of services, some of them are mentioned below as significance of working capital.
- Optimal Return on Current Asset Investment
- Minimize cost of capital
- Optimization of working capital operating cycle
- To evaluate the inventory, receivable and cash management performance.
- To know the profitability of the industry and its impact on the working capital.
Solvency of the business, adequate working capital helps in maintaining solvency of the business by providing uninterrupted flow of production. The exercise shall help in managing working capital at optimal level and thereby increase and maximize wealth of the firm.
We shall review the optimum working capital requirement of the company which is essential to maintain appropriate level of liquidity and profitability.
- Liquidity and Profitability: – For smooth functioning of the day to day business of an entity it is important to maintain liquidity of funds evenly. We have already learned that each rupee of capital bears some cost. So, while maintaining liquidity the cost aspects need to be borne in mind. Unnecessary tying up of funds in idle assets not only reduces the liquidity but also reduce the opportunity to earn better return from productive assets.
- Investment and Financing: – Working capital policy is a function of two decisions, first, investment in working capital and second id financing of the investment. Investment in working capital is concerned with the level of investment in current assets. It gives answer of ‘How much’ fund to be tied to achieve the organization objectives. 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.