Current assets can either be financed by use of short-term on long-term finds. For every firm, there is a minimum level of net working capital that is permanent. The magnitude of current assets needed is not always the same. It increases and decreases with time but this are always a minimum level of current assets which is continuously required by the firm to carry on its business operational. This minimum level is referred to as permanent fixed current assets.
Determinants of Working Capital Requirements of a firm
1. Nature of the Firm: A trading firm will usually require more working capital than a firm in the service industry e.g. a supermarket and a law firm
2. Size of the Firm: A larger firm would require comparatively more working capital than a smaller firm.
3. Business fluctuation : During times of high demand, affirm would require higher levels of working capital as compared to periods of low demand.
4. Growth stage of the firm: a mature firm requires less working capital than a firm in the infant stage.
5. Availability of credit from suppliers affects accounts payable.
6. The credit policy of the firm would affect accounts receivable.
Importance of Working capital Management.
The management of working capital is important because of the following reasons:
1. The time devoted to working capital management A large position of the finance manger’s time is devoted to the day to day operations of the firm: a lot of this time is spent on working capital decisions.
2. Investment in current assets represents a large portion of the total assets of many business firms therefore these assets need to be properly managed as they can easily be misappropriated by the firm’s employee’s since they are relatively volatile assets.
3. Importance to small firms: A small firm can minimize its investments in fixed assets by renting or leasing these assets but these is no way they can avoid investments in current assets. A small firm has relatively limited access to capital markets and therefore must rely on short-term funds to finance these operations therefore management of small firms is equivalent to management of working capital.
4. Relationship between sales and currents assets. This is a direct relationship between sales and current assets such that changes in working capital affect sales revenue and therefore profitability of the firm.
Working Capital Management Strategies
Working capital management interrelated goals:
(1) How to accelerate the collection of cash
(2) How to control cash disbursements
(3) How the appropriate working balance is determined
(4) How to invest any temporary idle funds in interest bearing marketable securities.
(5) How to forecast and manage cash shortages.
(6) Pay accounts payable as late as possible without damaging the firm’s credit rating. The firm should, however, take advantage of any favorable cash discounts.