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Aim of Working Capital / Homework Help
Aim of Working Capital Management

Working Capital Management:

Working Capital Management refers to the planning, execution and control of investment in and financing of working capital. Working capital management is concerned with the problems that arise in attempting to manage the current assets, the current liabilities and the inter-relationships that exist between them. The basic ingredients of the theory of working capital management may be said to include its definition, need, optimum level of current assets, the trade-off between profitability and risk associated with a firm's level of current assets and current liabilities, financing-mix strategies and so on.


Aims of Working Capital Management:
  • The goal of working capital management is to manage the firm’s current assets and current liabilities in such a way that a satisfactory level of working capital is maintained, to meet the short-term obligations as and when they arise.
  • A significant objective of working capital management is to ensure short-term liquidity and to see that profitability is not affected by the way current assets and current liabilities are managed.
  • The main theme of working capital management is the interaction between the current assets and the current liabilities and arrives at the optimum level of both. The optimum level thus arrived must have provision for contingencies.
  • Trade-off between Profitability and Risk: The level of a firm’s Net working capital has a bearing on its profitability as well as risk. The term profitability used in this context is measured by profits after expenses. The term risk is defined as the probability that a firm will become technically insolvent so that it will not be able to meet its obligations when they become due for payment. The risk of becoming technically insolvent is measured using Net Working Capital. The greater the net working capital, the more liquid the firm is and therefore the less likelihood of it becoming technically insolvent. The relationship between liquidity, net working capital and risk is such that if either net working capital or liquidity increases, the firm's risk decreases.
  • Trade-off: If a firm wants to increase its profits, it must also increase its risk. Inversely, if it decreases risk, its profitability too tends to decrease. The trade-off between these variables is that regardless of how the firm increases its profitability through the manipulation of working capital, the consequence is a corresponding increase in risk as measured by the level of Net working capital.
  • Apart from the profitability – risk – trade-off, another important ingredient of the theory of working capital management is determining the financing mix. Financing mix refers to the proportion of current assets that would be financed by current liabilities and by long-term resources.

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