## Scope of Working Capital Management
The scope of WC Management covers two core areas:
1. Liquidity and Profitability trade-off
2. Investment and Financing decisions
---
### A. Liquidity vs Profitability Trade-off
| Component | Higher Level Advantage (Profitability) | Lower Level Advantage (Liquidity) | Optimisation Tool |
|---|---|---|---|
| Inventory | Fewer stock-outs; more sales | Less capital tied up | EOQ, JIT |
| Receivables | More customers; more revenue | Better cash liquidity | Factoring, early-payment discounts |
| Prepaid Expenses | Reduces uncertainty (esp. in inflation) | Conserves cash | Cost-benefit analysis |
| Cash | Timely payments; supplier discounts | Invest surplus elsewhere | Cash budgeting |
| Payables | Keep capital longer for other uses | Timely payment = goodwill & discounts | Evaluate credit terms & costs |
Core Tension:
```
Too much WC → idle funds → low profit
Too little WC → cash crunch → default risk
```
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### B. Investment Decision – How Much to Invest in Current Assets?
| Approach | Characteristics | Advantage | Risk |
|---|---|---|---|
| Aggressive | Minimum CA; strict credit, low cash, minimum inventory | Higher return on capital, lower financing cost | Liquidity crisis, stock-outs |
| Conservative | High CA; large inventory, liberal credit, high cash | High liquidity, low operational risk | Idle funds, higher cost of capital |
| Moderate | Balanced between the two extremes | Acceptable liquidity AND profitability | Moderate risk |
#### Measuring Approach: CA/FA Ratio
CA/FA Ratio = Current Assets ÷ Fixed Assets
| Ratio | Implied Policy |
|---|---|
| High | Conservative (more CA relative to FA) |
| Low | Aggressive (fewer CA relative to FA) |
---
### Factors Affecting Level of Investment in WC
| Factor | Effect |
|---|---|
| Nature of Industry | Construction, breweries → long gestation → high WC investment |
| Type of Product | Consumer durables → high inventory; perishables → low inventory |
| Manufacturing vs Trading vs Service | Manufacturer: 3 inventory levels (RM, WIP, FG); Trader: stock only; Service: consumables |
| Volume of Sales | Higher sales → higher receivables |
| Credit Policy | Liberal credit → high receivables + more capital needed for RM purchases |
---
### C. Financing Decision – From Where to Fund WC?
| Type of WC | Appropriate Financing Source |
|---|---|
| Permanent WC | Long-term funds (equity, long-term debt) |
| Temporary WC | Short-term funds (bank overdraft, trade credit, factoring) |