Profitability and liquidity are the two ultimate twin goals of any firm. But these two often give rise to conflicts since liquid assets give the lowest returns. If firms don’t care about profit, they can’t endure for a longer period. Likewise, if they don’t care about liquidity, they may face insolvency or worse, bankruptcy. Thus, there must be a trade off between the two objectives. For these reasons, working capital management which involves the relationship between current assets and current liabilities must be given proper attention and consideration.
Working capital, as defined by Brigham and Houston, sometimes called gross working capital, simply refers to current assets used in operations. A manufacturing business invests heavily on raw materials for the production of their inventories and may be owed a large amount of money by debtors, thus it needs a well thought out receivable management policy. While a trading concern business such as a food retailer depends on large inventories for resale but may not grant credit, thus it will focus on its inventory management. As a result, the level of current assets companies must choose to operate should depend on the nature of their businesses.
To determine the right level of balances or the right mix of current assets they should maintain to minimize the cost of handling those assets, there is a need of formulating appropriate and effective policies on the management of cash, marketable securities, accounts receivable and inventories in order to avoid the possibility of coming up with decisions that are not of the interests of the company. In case of cash management, companies must not maintain high level of cash because these are non earning assets. They must know where to invest cash surplus if there is. But if there’s none, they must devise ways that will not lead them to cash shortage such as reducing cash conversion cycle. This is not only true in businesses, but also to us commoners. When we intend to save the excess of our daily earnings allowances, it’s better to put it in banks to let it grow in terms of interest than letting it sleep in our safety boxes at home.
Inventories should be available whenever needed. Inventory management must do their best in minimizing ordering and carrying costs so that they can achieve their targeted profit. For collecting accounts receivables, firms ought to practice certain collecting policies such as giving discounts for prompt payments. As a conclusion, current asset management is a key factor in the company’s long term success. Managing current assets is not an easy task because unawareness of effective and efficient handling of these assets will likely bring difficulty in paying short term debt obligations from operational sources of cash in sustained or sudden decline in sales if they have no current assets or have very minimal current assets. We always perceived scarcity as a negative element but excess should also be one. As the saying goes, “If in excess even nectar is poison.” Thus, firms must maintain sufficient assets.