Working Capital Decisions
Working capital decisions relate to the relationship between a firm’s current assets and its current liabilities. Working capital is the difference between current assets and current liabilities. Working capital has a direct bearing on the firm’s liquidity or ability to meet short-term liabilities from short term assets especially cash being the most liquid asset. Working capital decisions involve deciding the optimum level of net current assets or working capital necessary to sustain the operations of the business.
The crux lies in understanding that having too little cash is not good as it may lead to deficits of stocks or require the selling of part of fixed assets or seeking other long term debt financing like long term bank loans meant for buying fixed assets to finance stock purchases. On the other hand, having very high levels of cash is not healthy for the firm because it means some cash is lying idle which could be used to finance expansion of production capacity by acquiring or buying of extra fixed assets.
Factors Influencing Working Capital Decisions
To make good working capital decisions we have to involve the techniques of working capital management. The most important of these techniques include;
- Cash management policies: These are methods of managing and ensuring cash is safe and is not misused. It may include setting up financial accounting systems and procedures and putting up physical controls like safes and steel doors to ensure accountability for and safety of cash.
- Debtors management which may involve setting up incentive schemes to motivate and encourage debtors to pay early like offering large trade discounts for debtors who pay early. This ensures a quick turnaround for receivables.
- Having stock management policies that maintain optimum stock levels, eradicate excess stocks and avoid scarcity of stocks for sale.
- Adopting creditor management policies which ensure the firm has a list of various creditors so as to source from the suppliers with the lowest credit interest rate and the longest repayment periods.
Implementing these working capital management policies will create a window to siphon extra cash generated to acquisition of fixed assets and hence expansion and growth while ensuring excellence in operations of the frim