Assignment

Capital Management
What Is Working Capital Management?
Working capital management is a business strategy designed to ensure that a company operates
efficiently by monitoring and using its current assets and liabilities to their most effective use.The
efficiency of working capital management can be quantified using ratio analysis.
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What Are The 4 Main Components Of Working Capital?
working capital component
One of the most common ways to gauge the short-term health of an organization is to measure its
working capital. Working capital is crucial for maintaining operations, managing business growth, and
fueling business strategies that directly impact your company’s bottom line.
Estimates of working capital, also known as net working capital (NWC), are derived from the vast array
of assets and liabilities on a corporate balance sheet, such as:
Current assets: cash, accounts receivable (customers’ unpaid bills), inventories of finished products and
raw materials, and more
Current liabilities: accounts payable, bills, and debts such as payroll, vendor payments, or rent
By calculating the difference between immediate debts and liquid assets, companies can better
understand how much capital they will have in the near future. The working capital forecast usually
applies to a 12-month term.
Companies can also use working capital estimates to assess their operational efficiency, current cash
position, and short-term financial health. For example, positive working capital estimates can help
leaders make strategic investment and expansion decisions.
However, the company may face financial trouble if current liabilities exceed the existing liquid assets,
putting it in a negative working capital situation. This may be the time to take significant financial or
strategic action, so the company has enough cash to cover its bills and loan payments.
It’s important not to confuse working capital and operating capital. The difference between the two is
that while working capital gives you a short-term glimpse into the liquidity of a business, operating
capital applies more to a long-term view. Operating capital analyzes all long-term assets versus all long-
term liabilities to predict the company’s liquidity beyond the 12-month capital cycle.
The Working Capital Formula
One question many business owners ask is, what is included in working capital? Working capital can be
calculated by adding up all of a company’s current assets and current liabilities. Public companies usually
disclose these figures on publicly-disclosed financial/income statements. Private companies generally
don’t release financial statements to the public and may not be available.
Once you have the two figures, working capital can be calculated by applying them to this formula:
WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIESIn most cases, working capital is stated as
a dollar figure. Let’s look at two possible scenarios where a company has used this formula to calculate
its working capital:
Company A has $100,000 in current assets and $45,000 in current liabilities. By applying the formula, we
can determine that the company will have $55,000 in working capital over the short term. Company A
can use this money for various projects and initiatives to help it grow. It will also have sufficient working
capital to cover its short-term debts and cash left over if its current assets need to be liquidated to cover
those debts.
Company B has $100,000 in current assets but $120,000 in current liabilities. When we apply the
formula, we see a working capital total of -$20,000. This means that Company B doesn’t have enough
money to pay its short-term bills. Negative working capital totals signal a company’s poor short-term
health, low liquidity, and the risk of missing its debt obligations. Late payment penalties and any
applicable interest can make matters worse. Missing payments can also damage relationships with
suppliers and financial institutions.
The 4 Main Working Capital Components
Although only two factors might be required to calculate working capital, there is much more to it when
you scratch the surface. In reality, four distinct components are needed to calculate your company’s
current financial health.
The four main working capital components are:
 Cash (and cash equivalents)
 Accounts receivable (AR)
 Inventory
 Accounts payable (AP)
 Cash, AR, and inventory are all part of your company’s assets. Only AP belongs in the liability
column.
Let’s have a closer look at each of these four working capital components.
Cash (and Cash Equivalents)
Whether it is dollar bills on hand or cash in the bank, every business must have a cash reserve to pay
operating expenses when necessary. Nothing is more liquid than cash, making it a major component of
your working capital
Cash equivalents are also handy to have. These assets can be liquidated quickly without a sizable loss of
value. Examples of cash equivalents include money market funds, stocks, bonds, and mutual funds.
Accounts Receivable
Another class of assets included in your working capital calculation is accounts receivable. This category
refers to money owed to your company or cheques that you have received but not yet cashed. Once
you’ve collected payments and deposited your cheques into the bank, the funds become sales revenue
and fall into the cash category.
Examples of items that fall into the AR component of your working capital include:
 Open customer invoices
 Accrued interest on outstanding/late customer invoices
 Extended credit to other companies
Inventory
Inventory is another type of asset. It refers to tangible goods you have on hand that have not yet been
sold to customers. Until the products are sold, they fall into the inventory component that counts
toward assets when calculating your working capital.
Examples of inventory include products displayed in a brick-and-mortar store, stored in a warehouse
awaiting sale, or in transit from your supplier. Because you’re looking to sell products quickly, these are
also known as short-term assets.
Accounts Payable
Once you add up your cash, accounts receivable, and inventory, your accounts payable can be worked
into the equation. AP includes all of the liabilities you expect to have over the next 12 months. Debt
payments beyond 12 months are worked into your operational capital calculations.
Liabilities that are part of this key component of working capital include:
 Supplier or vendor invoices
 Short-term debt repayments on bank loans (loan principal and interest)
 Upcoming tax payments
 Unpaid dividends to investors
 Balances on business credit cards
 Wages payable to employees
 Operational expenses such as material costs and utility payments
 Leases on office, storage, warehouse, and other real estate
As a business owner, you naturally want to maximize the amount of working capital your company has
available. Automated AP and AR solutions can help you achieve that by streamlining many of your
accounting processes.
How Automation Can Improve Your Working Capital
Optimizing your AR processes through automation is one of the critical principles for improving your
working capital and growing your cash flow. Automation will help get your invoices paid faster and
significantly reduce the time your AR team spends following up on payments.
ACI’s Accounts Receivable Automation Solution for Cash Application process, AR Assistant™, improves
your working capital, employee productivity, and cost reduction without requiring a significant shift in
your business operations. Implementing Accounts Receivable Automation in your organization with
ACI’s cloud cash application software is simple and straightforward, and will have no impact on the flow
of your daily operations.

An automated solution also helps to drastically reduce the amount of paper used in your office by
moving everything online and into the cloud. Paper-free offices enjoy significant cost savings on office
supplies, storage, and time filing and retrieving documents.
Augment your AR automation with CheqMate™, our Remote Cheque Deposit solution. CheqMate™
allows you to have your cheque payments directed to your organization’s lockbox at our secure
document and data processing facility. Here’s how it works:Our team receives and opens your cheque
mail.Cheques are scanned to capture the image and relevant data.Cheques are electronically deposited
directly into your account at your preferred financial institution.
IMPORTANCE OF WORKING CAPITAL MANAGEMENT:
When a company’s current assets are more than its current liabilities, it is said to have positive working
capital. This means that the company is in a good position in terms of liquidity and financial health.
Hence, having a positive WC helps a company maintain its solvency. The various factors which highlight
the importance of working capital are as follows:
Managing liquidity: By getting a clear idea of impending expenses or expenses coming up, the finance
department can take stock of their financial position and arrange for the funds accordingly.
Avoiding out-of-cash position: Inappropriate planning to day-to-day expenses may cause liquidity issues.
In such a case, the company may have to postpone or arrange funds from other sources, which
negatively reflects the company’s image.
Helps decision-making: By correctly calculating the requirement of day-to-day funds, a company takes
stock of its current fund position. This allows the company to decide the amount and source of funds.
Adds value to the business: As the management arranges for funds to manage its day-to-day expenses,
the finance department can meet all its payment obligations. This sends out a positive message in the
market about the company and enhances its value.
Earn short-term profits: There are situations when a company has excess funds with them. By calculating
its working capital requirements, the company can estimate the amount of excess funds. Over and
above the working capital requirements, the company may invest extra funds for the short term and
earn some profit.