Importance of Adequate Working Capital
Management of working capital is an essential task of the finance manager. He has to ensure that the amount of working capital available with his concern is neither too large nor too small for its requirements.
A large amount of working capital would mean that the company has idle funds. Since funds have a cost, the company has to pay huge amount as interest on such funds.
If the firm has inadequate working capital, such firm runs the risk of insolvency. Paucity of working capital may lead to a situation where the firm may not be able to meet its liabilities.
The various studies conducted by the Bureau of Public Enterprises have shown that one of the reasons for the poor performance of public sector undertakings in our country has been the large amount of funds locked up in working capital. This results in over capitalization. Over capitalization implies that a company has too large funds for its requirements, resulting in a low rate of return, a situation which implies a less than optimal use of resources. A firm, therefore, has to be very careful in estimating its working capital requirements.
Maintaining adequate working capital is not just important in the short-term. Sufficient liquidity must be maintained in order to ensure the survival of the business in the long- term as well. When businesses make investment decisions they must not only consider the financial outlay involved with acquiring the new machine or the new building, etc., but must also take account of the additional current assets that are usually required with any expansion of activity. For e.g.:-
- Increased production leads to holding of additional stocks of raw materials and work-in-progress.
- An increased sale usually means that the level of debtors will increase.
- A general increase in the firm’s scale of operations tends to imply a need for greater levels of working capital.
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