Working capital - its importance
The
importance of working capital
Definition
of working capital
The
net working capital of a business is its current assets less its current
liabilities
Current
Assets include:
-
Stocks of raw materials - Work-in-progress - Finished goods -
Trade debtors - Prepayments - Cash balances
Current
Liabilities include: - Trade creditors - Accruals - Taxation
payable - Dividends payable -
Short term loans
Every
business needs adequate liquid resources in order to maintain day-to-day cash
flow. It needs enough cash to pay wages and salaries as they fall due and to
pay creditors if it is to keep its workforce and ensure its supplies.
Maintaining
adequate working capital is not just important in the short-term. Sufficient
liquidity must be maintained in order to ensure the survival of the business in
the long-term as well.
Even
a profitable business may fail if it does not have adequate cash flow to meet
its liabilities as they fall due.
Therefore,
when businesses make investment decisions they must not only consider the
financial outlay involved with acquiring the new machine or the new building,
etc, but must also take account of the additional current assets that are
usually involved with any expansion of activity.
Increased
production tends to engender a need to hold additional stocks of raw materials
and work in progress. Increased sales usually means that the level of debtors
will increase. A general increase in the firm’s scale of operations tends to
imply a need for greater levels of cash.
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