Back to: Financial Management
Hello, class!
I hope you are all doing well today. We’ve covered many exciting areas of financial management, and today’s topic is both strategic and operational—Working Capital Management.
It is the financial management of day-to-day operations in a business. Let’s explore how companies manage their short-term resources to ensure they remain liquid and operational.
Lesson Objectives:
By the end of this lesson, students should be able to:
Define working capital and explain its importance.
Identify components of working capital.
Differentiate between gross and net working capital.
Discuss the objectives and techniques of working capital management.
What is Working Capital?
Working capital is the capital used in the day-to-day operations of a business. It is a measure of a company’s operational efficiency and short-term financial health.
Formula:
Working Capital = Current Assets – Current Liabilities
Types of Working Capital:
Gross Working Capital:
Refers to the total value of current assets.
Net Working Capital:
Difference between current assets and current liabilities.
Components of Working Capital:
Current Assets:
Cash
Accounts receivable (debtors)
Inventory (stock)
Marketable securities
Prepaid expenses
Current Liabilities:
Accounts payable (creditors)
Short-term loans
Accrued expenses
Bank overdrafts
Importance of Working Capital Management:
Ensures liquidity and solvency.
Promotes efficient operations.
Enhances profitability through better asset utilisation.
Avoids overtrading or undertrading.
Helps in meeting short-term obligations.
Techniques of Working Capital Management:
Inventory Management:
Avoiding overstocking or understocking using tools like EOQ (Economic Order Quantity).
Receivables Management:
Monitoring debtor days and improving collection policies.
Cash Management:
Forecasting and controlling inflows and outflows.
Payables Management:
Maintaining good relationships with suppliers while managing payment timing.
Summary:
Working capital management is essential for the smooth functioning of any business. Without sufficient working capital, even profitable firms can face liquidity problems. A smart financial manager balances short-term assets and liabilities to optimise cash flow.
Class Activity / Discussion:
Scenario:
A mobile phone accessories shop is struggling to pay its suppliers on time even though it makes good sales. In groups, identify possible working capital issues and suggest ways to improve liquidity.
Evaluation (Assessment Questions):
What is working capital?
Differentiate between gross and net working capital.
List three current assets and two current liabilities.
Why is receivables management important?
Describe one method a business can use to manage its inventory effectively.