Discussion regarding issues raised in this assignment. I agree with your comments concerning the importance of working capital. This aspect of a company's financial operations is indeed very important and will determine much of the success for any company.
With that being said, let's now look at some specific elements that make up working capital. First, how do we calculate the current ratio? How is this related to working capital? What would be the minimum current ratio that we would look for in a financially healthy company? Also, what change to our current ratio would we see if the accounts receivables were collected more quickly?
This is the discussion:
Working capital can be defined as any amount which is invested in the business that will be used only for running the daily business operations of the organization, like credit sales, credit purchases, notes receivable, notes payable, short-term loans, etc.
The amount allocated for working capital cannot be used for long-term investment in purchasing fixed assets.
Working capital is required mainly to pay for short-term obligations like credit purchases. Generally, the credit is given to us by our creditors. In such a case, the amount will not be available to pay the creditor before the due date. In such cases, we go for short-term loans, working capital loans from banks, lines of credit, etc.
To ensure operational needs are met through short-term financing, we can check whether the payments to creditors are made correctly. If the payments to creditors, bill/note payable payments, short-term loan repayments, are made correctly before the due date, then we can say that the organization's operational needs are met.
We need to:
- Maintain good relations with the supplier
- Obtain or maintain a good credit score
- Obtain credit facilities like short-term loans from banks or lenders
Goods purchased on credit from suppliers are again supplied to our customers on credit. So, our customers are shown as debtors under the heading current assets on the asset side of the balance sheet.
Similarly, goods purchased on credit from suppliers but not yet sold to any customer will be shown as inventory under the heading current assets.
So, debtors and inventory are regarded as assets of the business, which originated as assets given by the supplier.
Current assets:
Current liabilities
Working capital.
So the remaining working capital is nothing but the current asset.