Question

What is the significance of working capital?

Answer 1

Investment in fixed assets only is not sufficient to run the business. Working capital or investment in current assets, howsoever small it is, is a must for purchase of raw materials, and for meeting the day-to-day expenditure on salaries, wages, rents, advertising etc., and for maintaining the fixed assets. “The fate of large scale investment in fixed capital is often determined by a relatively small amount of current assets.” Working capital is just like a heart of industry if it is weak, the business cannot prosper and survive, although there is a large body (investment) of fixed assets. Moreover, not only the existence of working capital is a must for the industry, but it must be adequate also. Adequacy of the working capital is the lifeblood and controlling nerve center of a business. Inadequate as well as redundant working capital is dangerous for the health of industry. It is said, ‘Inadequate working capital is disastrous; whereas redundant working capital is a criminal waste’. Both situations are not warranted in a sound organization.   The advantages of working capital or adequate working capital may be enumerated as below: -   1.Cash Discount: If a proper cash balance is maintained, the business can avail the advantage of cash discount by paying cash for the purchase of raw materials and merchandise. It will result in reducing the cost of production.   2.It creates a Feeling of Security and Confidence: The proprietor or officials or management of a concern are quite carefree, if they have proper working capital arrangements because they need not worry for the payment of business expenditure or creditors. Adequate working capital creates a sense of security, confidence and loyalty, not only throughout the business itself, but also among its customers, creditors and business associates.     3.‘Must’ for Maintaining Solvency and Continuing Production:  In order to maintain the solvency of the business, it is but essential that the sufficient amount t of fund is available to make all the payments in time as and when they are due. Without ample working capital, production will suffer, particularly in the era of cut throat competition, and a business can never flourish in the absence of adequate working capital.   4.Sound Goodwill and Debt Capacity: It is common experience of all prudent businessmen that promptness of payment in business creates goodwill and increases the debt of the capacity of the business. A firm can raise funds from the market, purchase goods on credit and borrow short-term funds from bank, etc.  If the investor and borrowers are confident that they will get their due interest and payment of principal in time.   5.Easy Loans from the Banks: An adequate working capital i.e. excess of current assets over current liabilities helps the company to borrow unsecured loans from the bank because the excess provides a good security to the unsecured loans, Banks favor in granting seasonal loans, if business has a good credit standing and trade reputation.   6.      Distribution of Dividend: If company is short of working capital, it cannot distribute the good dividend to its shareholders inspite of sufficient profits. Profits are to be retained in the business to make up the deficiency of working capital. On the other contrary, if working capital is sufficient, ample dividend can be declared and distributed. It increases the market value of shares.       7.Exploitation of Good Opportunity: In case of adequacy of capital in a concern, good opportunities can be exploited e.g., company may make off-season purchases resulting in substantial savings or it can fetch big supply orders resulting in good profits.   8.Meeting Unseen Contingency: Depression shoots the demand of working capital because sock piling of finished goods become necessary. Certain other unseen contingencies e.g., financial crisis due to heavy losses, business oscillations, etc. can easily be overcome, if company maintains adequate working capital.   9.High Morale: The provision of adequate working capital improves the morale of the executive because they have an environment of certainty, security and confidence, which is a great psychological, factor in improving the overall efficiency of the business and of the person who is at the hell of fairs in the company.   10.Increased Production Efficiency: A continuous supply of raw material, research programme, innovations and technical development and expansion programmes can successfully be carried out if adequate working capital is maintained in the business. It will increase the production efficiency, which will, in turn increases the efficiency and morale of the employees and lower costs and create image among the community.