The Working Capital Policy

The essential ingredients of a working capital management policy of a company are decisions made to set:

a. The level of gross working capital (i.e. current assets) to be carried by the company. This brings us to the question as to how much current assets are appropriate to the need and operational capacity of the company. We will discuss this aspect of the working capital policy in later paragraphs of this chapter.

b. What portion of the GWC should be financed through raising short term finance, i.e. through current liabilities? Many, if not all, of these current liabilities arise as a result of purchase of current assets. For example, goods are often bought on credit, leading to creation of an asset (Stocks) as well as a current liability (Trade Creditors). This brings us to the question as to what is the appropriate level of current liabilities to be carried by the company in light of its operational needs.

c. Whatever portion of the GWC capital is not financed by current liabilities has to be financed by long term funds. Now this brings us to the most important aspect of working capital policy. Should current assets be financed by long term funds at all? To what extent is it proper to finance current assets with current liabilities and beyond which level it becomes necessary to raise long term funds for meeting current assets financing? This can be quite tricky. The solutions will differ for those companies who generally operate at more or less the same levels throughout a financial year, and those companies that experience seasonal fluctuations in their operations during the year. We will talk about these aspects of managing working capital in later part of this chapter.

If a company's current assets are exactly equal to its current liabilities, it means all of the gross working capital is being financed by current liabilities. Thus such a company will have no net

...