Working Cpital Management

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Working Capital Policy and Liquidity in

the Small Business


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Introduction

Working capital management is one of the mostcritical elements in the operation of a smallbusiness. The two components of workingcapital are:

Gross working capital: sum of current assets of a

firm. Net working capital: Current assets-Current

liabilities.


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Importance of working capital

Small business are involved in retailing andwhole selling, current assets play a major role.

Small business have difficulty in obtaining longterm financing due to which it should efficiently

manage its working capital to manage the needfor finance.


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Objective

The main objective of this study is to describethe working capital policy and liquidity in smallbusinesses.

Methodology

A descriptive research design has been used forthis study since it involves theoretical concepts.


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Concepts highlighted in the article

Working capital policy:

Working capital policy is the set ofprinciplesand plans that establishes a courseof action for dealing with current assets andcurrent liabilities. There are two views on

working capital policies:1. On the basis of net working capital

2. On the basis of the amount of long termfinancing used.


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On the basis of net working capital

A working capital policy can be:

1. Aggressive : high degree of short termfinancing to finance assets

2. Conservative : preference to hold more cash

3. Moderate : it balance between long and short

term financing


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Determinants of net working capital

1. Liquidity

2. Deferability of current liabilities


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1. Liquidity

As we know liquidity is the ability of an asset tobe converted into cash with minimal loss. Thefactors of working capital that affect liquidity are:


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Operational aspects of the firm:

It includes utilization of inventory turnover ratio, credit sales,receivables collection period etc all of which are in theworking capital policy.The marketing area of the policy influences the operationalaspects of the firm.

The amount of cash held by the firm is also mentioned, highercash holding higher liquidity.

Non-operational aspects of the firm:It refers liquidation value of current assets.

It depends on the magnitude and degree of current assets and

the ability to dispose them with minimal loss.

Forecast future sales:The higher the ability to forecast sales, more

liquid the current assets. However small firms have difficultyin forecasting, thus affecting cash levels.


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2. Deferability of current liabilities

Deferring or postponing the accruals can alsoincrease liquidity. However the postponability of

accruals is difficult to accounting or legal nature. The average payment period, which is a

mentioned in working capital policy can beincreased or decreased.

Notes payable is generally not postponable, it isrenewable. The decision whether to renew or notdepends on the lenders ability, economic factorsand the current state of the firm.


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Aggressive working capital policyAn aggressive policy is one that has: Above average profit margin Current assets high proportion of total assets High degree of short term financing Above average inventory turnoverRewards: Low inventory costs, due to fast moving inventory Lower collection cost due to aggressive credit and collection

policy Lower financial cost due to short term financing

Risks: Inability to meet short term obligations Short term financing may not be available during recession Average payment period extension is generally not accepted

to suppliers


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On the basis of the amount of long term

financing used

This view emphasizes that the larger proportionsof long term financing create higher levels ofworking capital. Also small business suffers fromlack of long term financing. So net workingcapital is inadequate.


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Summary and conclusion

It attempts to place working capital policy inperspective with other policies in small business.

Working capital policy must be expressed interms of liquidity, deferability of sales andconsumption of financing.

The working capital policy is of vital importanceto a small business.


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Working Cpital Management