NEED AND SIGNIFICANCE OF WORKING CAPITAL
The primary objective of a business corporation is to maximize shareholders' wealth by
earning sufficient profit through effective operations and increased sales. A
firm needs working capital for its daily operations. Raw materials, inventories
are needed for manufacturing. Due to the time lag between manufacturing of
finished goods and sales, a firm needs cash for financing inventories; bills receivables and other
routine expenses.
If an adequate amount of working capital is not available
for this gap period, the firm will not be in a position to sustain its business
operations. Further, the time gap between the sales and their actual
relaisation in cash is technically termed as 'operating cycle' of the business.
Regular availability of adequate working capital is
inevitable for sustained business operations. A company must, therefore, have
adequate working capital, i.e., as much as needed by the company. It should
neither be excessive nor inadequate. Both, inadequate and redundant working
capital situations are dangerous. It is rightly said, “Inadequate working
capital is disastrous; whereas redundant working capital is a criminal waste.”
The advantages and
importance of adequate working capital are enumerated as follows :-
Increase in Debt Capacity and Goodwill-
Adequate working capital represents the
financial soundness of a company.
Promptness in payments creates goodwill and increases the debt capacity of the
firm. Regular availability of adequate working capital creates confidence among
investors and lenders that they will get their due interest and principal in
time. Thus, a firm with adequate working capital can raise the requisite funds
from market, borrow short-term credit from banks and purchase inventories of raw
materials, etc., for the smooth operations of its business.
Facility in Obtaining Loans from Financial Institutions:
Adequate working capital representing excess of current assets over current
liabilities is considered as an ideal security for trade credits. Thus, the presence
of adequate working capital and current assets help a company to raise
unsecured and secured loans from financial institutions.
Increase in Production Efficiency:
If adequate working
capital is maintained in the business, the firm can successfully carry out its
operations, research and development programmes etc., which would lead to
increased production efficiency. Production efficiency, in turn, will increase
the efficiency of the employees and boost up their morale. Further, it would
also enable the company to discharge its social responsibility towards the
society.
High Executive Morale:
Maintenance of adequate working
capital also boosts up the morale of the executive insofar as they have an
environment of creativity, security and confidence, which is an important
psychological factor in improving the efficiency and morale of the business
executives who are at the helm of
affairs in the firm.
Exploitation of Favourable Opportunities:
In the presence
of adequate working capital, a company can avail the benefits of favourable
opportunities. For example, the having adequate working capital can avail the
benefits company of bulk supply orders, bulk purchases of raw materials, off
season purchases, etc.
Meeting Contingencies and Adverse Changes:
In case of
adequate working capital, a company can easily face certain business and
economic crises. For example, the demand for goods decreases during the
depression period and the payment of credit sales is also made after a long
period. In this case, companies with adequate working capital can only
successfully meet this adverse situation. Certain other contingencies, such
as--business oscillations, financial crisis arising from heavy losses etc., can
be successfully met by a company having adequate working capital.
Availing Cash Discount:
Maintenance of adequate working
capital enables a company to avail the advantage of cash discount by making
cash payments for to the suppliers of raw materials and merchandise. Obviously
it will reduce the cost of production and increase the profits of the company.
Attractive Dividend to Shareholders:
Adequate working capital
enables a company to declare and
distribute attractive dividend to its shareholders. Conversely a company not
having adequate working capital cannot distribute attractive dividends in spite of sufficient profits. Moreover, distribution
of good dividend also increases the market value of shares.
Sense of Security and Confidence:
Adequate working capital
creates a the business sense of security and confidence not' only among executives
but also the customers, creditors and business associates.
Solvency and Efficiency of Fixed Assets:
Adequate working capital also increases the efficiency of fixed assets insofar as their proper maintenance depends upon the availability of funds. It has been rightly said, "The fate of large scale investment in fixed assets is often determined by a relatively small amount of current assets.
