## Scope of Working Capital Management
WC Management covers two core areas:
1. Liquidity vs Profitability trade-off
2. Investment and Financing Decisions
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## A. Liquidity vs Profitability Trade-off
- Too much WC → Idle funds → Low profitability
- Too little WC → Cash crunch → Risk of default
### Component-Level Trade-offs
| Component | Higher Level Benefit (Profitability) | Lower Level Benefit (Liquidity) | Balance Tool |
|---|---|---|---|
| Inventory | Fewer stock-outs; higher sales | Less capital tied up | EOQ, JIT |
| Receivables | More customers; more revenue | Better cash flow | Factoring, credit limits |
| Prepaid Expenses | Reduces uncertainty; inflation hedge | Conserves liquidity | Cost-benefit analysis |
| Cash | Timely payments; supplier discounts | Invest surplus elsewhere | Cash budgeting |
| Payables | Delay payment → more capital for other uses | Timely payment → goodwill, discounts | Evaluate credit terms |
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## B. Investment and Financing Decisions
### Investment Decision: How much to invest in current assets?
| Approach | Current Asset Level | Advantage | Disadvantage |
|---|---|---|---|
| Aggressive | Minimum (low inventory, strict credit, low cash) | Higher return, lower financing cost | Liquidity risk, stock-outs |
| Conservative | High (large inventory, liberal credit, high cash) | High liquidity, low operational risk | Lower return, idle funds, higher cost |
| Moderate | Balanced | Acceptable liquidity and profitability | Requires ongoing monitoring |
### CA/FA Ratio
$$\text{CA/FA Ratio} = \frac{\text{Current Assets}}{\text{Fixed Assets}}$$
- High ratio → Conservative approach
- Low ratio → Aggressive approach
### Factors Affecting Level of Investment in WC
1. Nature of industry — Construction/breweries need large WC (long gestation periods).
2. Type of product — Consumer durables hold more inventory than perishables.
3. Manufacturing vs Trading vs Service — Manufacturing maintains 3 inventory levels (RM, WIP, FG); trading maintains only trading stock.
4. Volume of sales — Higher sales → higher receivables.
5. Credit policy — Liberal credit → high receivables + more capital needed for raw material purchases.
### Financing Decision: From where to arrange WC funds?
- Permanent WC → Long-term sources (equity, long-term loans)
- Temporary WC → Short-term sources (bank credit, supplier credit, factoring)