Component And Objective Of Working Capital

Question 1

Objective of Working capital

Answer 1

Here are the smart notes:

Working Capital

Definition: Capital required to support everyday operations.
Components: Inventories, cash, short-term investments, and trade receivables.

Objectives of Working Capital Management

1. Ensure investment in working capital is not excessive.
2. Ensure sufficient working capital is available to support operating activities.
3. Manage surplus cash and short-term investments.

Avoiding Excessive Working Capital

Cost of working capital: Financed by long-term capital (equity or debt).
No direct financial return: Investment in inventory and trade receivables does not provide additional financial returns.

Avoiding Liquidity Problems

Shortage of working capital: May result in liquidity problems and insolvency.
Operational cash flows: Come from sale of inventories and payment by customers.

Conflict of Objectives

Over-investment: Reduces profits or returns to shareholders.
Under-investment: Creates a liquidity risk.
Balancing act: Working capital management involves balancing these conflicting objectives.