Researching: Minimizing Working Capital

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Summary

Working capital is a special financial metric that is calculated from the difference between the fixed assets of the company, that is, those outside the turnover and the financial obligations of the company. A company’s liquidity is usually measured in terms of the company’s ability to pay off short-term liabilities. The ability to handle working capital is able to maintain the company and effectively manage the company. If its volume is insufficient, the company will not be able to fulfill its obligations, which can reduce the level of salaries, and force the company to lose the loyalty of partners and suppliers. In order to determine the level of expediency of the size of working capital, it is required to understand the purpose of its use. In the case of a desire for liquidity, capital should be higher, but companies also desire profitability, which requires a lower level of investment. There are numerous reasons for companies’ need to underestimate the liquidity ratio, that is, to minimize working capital for the timely use of financial savings.

Conditions

Liquidity means the ability to sell a particular product quickly and at a market price; that is, liquidity is the probability of exchanging a thing for money. Therefore, depending on the company and the goods produced by it, the amount of distributed and invested finance should be determined. An important benefit of understating or keeping working capital low will be the increased efficiency of operations. If a company makes money with quick deals and sells goods immediately and for cash, it can complete a turnover cycle faster. Thus, the company operates more quickly and efficiently, and it does not need much liquidity support since it is able to cover all costs as they appear.

The optimal level of the constituent parts of the working capital should be measured depending on the type of operations and the long-term investment plans. According to researchers’ observation, many companies do not realize that increasing liquidity through a large number of financial investments in a company does not mean that the company’s value will automatically increase (Cumbie & Donnellan, 2017). In the case of companies striving for profitability, capital should be measured on a daily basis in order to ensure smooth day-to-day operations. Accounts receivable require particular caution, the amount of which should be understated to increase the company’s profitability.

One can minimize the company’s investments in the following ways: reduce your stocks, reduce the terms of the loan provided to customers, or increase the terms of the loan received from the suppliers. This will reduce the investment or the long-term investment of the company. The money obtained in this way can, for example, be invested in permanent assets and increase profitability. In this case, if one removes this money from the working capital and maintains profitability, the company’s rentability will increase as an indicator of profit in relation to the cost of the capital involved.

In order for the company to be able to increase its value while maintaining a low level of liquidity, an increase in the number of accounts received and paid is required. This implies an increase and acceleration of the conversion of finance. The company also requires periodic additional inventories to adapt to changes in the economic landscape in the situation of deteriorating business conditions (Tsuruta, 2019). Through qualitative research carried out in the firm, one can also find out which financial components are the main ones to ensure the value of the firm. Thus, depending on the balance between liquidity and profitability, the company’s tasks are determined, which already form the necessary conditions for reducing or maintaining a low level of working capital.

Challenges

The main risk in the release of finance in the process of declining working capital may be the inability to meet financial obligations. Free cash flow rises as the company either sell off inventory or raises its debt or maturity times. By increasing the free cash flow, it becomes possible to increase dividends or pay off debts, but the danger of this is that the financial stability of the enterprise can be undermined (Van et al., 2019). The company risks losing its ability to respond financially to its short-term obligations.

Thus, the reduction of capital in use should be made carefully and sensibly, taking into account each component. Moreover, the risk of disadvantage and financial loss with low working capital is a prolonged cycle of money turnover. If the company does not sell the product quickly enough, while less money is spent on its preparation, there is a risk that the financial contribution will not pay off. This can lead to devastating consequences for a company that does not have time to replenish spent assets and does not have a safety cushion in the form of high liquidity.

The most suitable conditions for a low level of working capital are considered to be reduced in terms of money conversion, operations performed immediately on demand, every day, or exactly on time. The amount of capital itself does not affect the profitability of the company and the increase in deductions. However, the minimum capital is required to conduct operations. In the event of a successful circulation of capital, the proceeds go to other more productive uses. However, issues such as the limited amount of time and the high level of multitasking are certainly barriers for many companies striving for this type of profitability.

References

Cumbie, J. B., & Donnellan, J. (2017). The impact of working capital components on firm value in US firms. International Journal of Economics and Finance, 9(8), 138-151. Web.

Tsuruta, D. (2019). Working capital management during the global financial crisis: Evidence from Japan. Japan and the World Economy, 49, 206-219. Web.

Van, H. T. T., Hung, D. N., Van, V. T. T., & Xuan, N. T. (2019). Managing optimal working capital and corporate performance: Evidence from Vietnam. Asian Economic and Financial Review, 9(9), 977-993. Web.

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BusinessEssay. (2023) 'Researching: Minimizing Working Capital'. 15 January.

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BusinessEssay. 2023. "Researching: Minimizing Working Capital." January 15, 2023. https://business-essay.com/researching-minimizing-working-capital/.

1. BusinessEssay. "Researching: Minimizing Working Capital." January 15, 2023. https://business-essay.com/researching-minimizing-working-capital/.


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