CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Every business needs investment to procure fixed assets, which remain in use for a longer period. Money invested in these assets is called ‘Long term Funds’ or ‘Fixed Capital’. Business also needs funds for short-term purposes to finance current operations. Investment in short term assets like cash, inventories, debtors etc., is called ‘Short-term Funds’ or ‘Working Capital’. Working capital refers to that part of the firm’s capital which is required for financing short term or current assets such as cash, marketable securities, debtors and inventories. Funds, thus, invested in current assets keep revolving fast and are being constantly converted into cash and this cash flow out in exchange for other current assets. Hence it is also known as circulating capital or revolving capital or short term capital. The ‘Working Capital’ can be categorized, as funds needed for carrying out day-today operations of the business smoothly. The management of the working capital is equally important as the management of long-term financial investment. According to Genestenberg:- “Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another, as for example, from cash to inventories, inventories to receivables into cash.” The working capital is needed for the following purposes:-
1. For the purchase of raw materials, components and spares.
2. To pay wages and salaries.
3. To incur day-to-day expenses and overhead costs such as fuel, power and office expenses etc.
4. To meet the selling costs as packing, advertising etc.
5. To provide credit facility to customers. Working capital policy is an important issue in any organization because without the proper management of working capital components it will be difficult for the organizations to run its operations smoothly.
running (Lawrence and Charles, 1985). Its effective provision can ensure the success of a business while its inefficient management can lead not only to losses but also to the ultimate downfall of what might otherwise be a promising concern. Business success heavily depends on the ability of financial executives to effectively manage receivables, inventory, and payables (Filbeck and Krueger, 2005). Furthermore working capital policy has been major issue especially in developing countries. Adequate working capital needs to be maintained in order to discharge day-to-day liabilities and to protect the business from adverse effects (Sayaduzzaman, 2006; Siddiquee and Khan, 2009). It aims at protecting the purchasing power of assets and maximise the return on investment. Working capital is basically the portion of asset required by a business in current operations. In its gross form, it is the investment in current assets. However, it can also be described in its net form as the difference between current assets and current liabilities. In most organizations, current assets occupy a significant portion of the total asset structure. This invariably requires efficient management of it. Working capital management is concerned with managing the different components of current assets (inventories, debtors/receivables, cash/bank, shortterm investments, prepaid expenses) and current liabilities (creditors/payables, provision for tax, other provisions against the liabilities payable within a period of 1 year). The issues involved in managing working capital of any firm are concerned with the management of the firm’s inventory, cash, marketable securities, receivables and payables etc, In order to achieve a proper balance between risk and return. A well-designed and implemented working capital management must contribute positively to the creation of a firm’s value (Zirayawati et al., 2009; Afza and Nazir, 2007). For maximising profits or minimising of working capital cost or to maintain a balance between liquidity and profitability, there is a need to optimise working capital (Padachi et al., 2008). Too little investment in working capital i.e. aggressive working capital policy can lead to disruption in production, increases the risk of not being able to meet the financial obligations and impairs profitability. At the same time a conservative financing policy i.e. too much investment in working capital means idle funds that can earn no profit but involves cost. So, a financial manager has to be vigilant in maintaining appropriate levels of working capital.