Working Capital

The objective of working capital management is to maintain the optimum balance of each of the working capital components. This includes making sure that funds are held as cash in bank deposits for as long as and in the largest amounts possible, thereby maximizing the interest earned. However, such cash may more appropriately be "invested" in other assets or in reducing other liabilities.
Working capital management takes place on two levels:
• Ratio analysis can be used to monitor overall trends in working capital and to identify areas requiring closer management.
• The individual components of working capital can be effectively managed by using various techniques and strategies.
When considering these techniques and strategies, departments need to recognize that each department has a unique mix of working capital components. The emphasis that needs to be placed on each component varies according to department. For example, some departments have significant inventory levels; others have little if any inventory.
Furthermore, working capital management is not an end in itself. It is an integral part of the department's overall management. The needs of efficient working capital management must be considered in relation to other aspects of the department's financial and non-financial performance.
Financial ratio analysis calculates and compares various ratios of amounts and balances taken from the financial statements.
The main purposes of working capital ratio analysis are:
• to indicate working capital management performance; and
• to assist in identifying areas requiring closer management.
Three key points need to be taken into account when analyzing financial ratios:
• The results are based on highly summarized information. Consequently, situations which require control might not be apparent, or situations which do not warrant significant effort might be unnecessarily highlighted;
• Different departments face very different situations. Comparisons between them, or with global "ideal" ratio values, can be misleading;
• Ratio analysis is somewhat one-sided; favorable results mean little, whereas unfavorable results are usually significant.
However, financial ratio analysis is valuable because it raises questions and indicates directions for more detailed investigation.

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