working capital management essay

working capital management essay

Optimizing Working Capital Management: Strategies for Sustainable Business Growth

1. Introduction to Working Capital Management

The main purpose of this study is to analyze the impact of working capital management on profitability of companies operating in the cement manufacturing and distribution chains in Indonesia. Our data sample consists of eight companies, namely five from cement manufacturing and three from cement distribution chains. We applied panel data regression analysis for the period 2007 to 2014. The results suggest that one of the working capital management variables comprising average payment period for trade accounts payable significantly affects company profitability. The remaining working capital management components of cash conversion cycle, average collection period for trade accounts receivable, and inventory conversion period, do not have an impact on company profitability. These results suggest that effective management of trade accounts payable can represent an important factor in improving the profitability of cement companies. For cement manufacturing companies, a high value of average payment period for trade accounts payable results in increased profitability whereas the reverse is true for distribution chain companies.

2. Key Components of Working Capital

Inventory management is focused on ensuring that the company has just the right level of stock needed to meet the demand and avoid carrying excess stock. It should also be prevented from stock drain which can disrupt the ability to supply customers. Payable management looks at managing suppliers in such a way that the company is able to finance its operations from creditors for as long as possible. This is advantageous for the company as they can invest any excess cash into money generating programs while avoiding liquidity. The longer credit period also leads to a reduction in the cost thus helping the company. The third component of working capital management is receivables management where a business objective is always to recover the sale amount as soon as it is made. However, give too little credit period and the business might lose customers opting for longer credit period providers.

1. Inventory Management 2. Receivables Management 3. Payable Management

Without a clear understanding of what comprises working capital, it becomes tough to manage the same and even more challenging to optimize it. There are three major components of working capital that need to be managed, namely:

3. Importance of Efficient Working Capital Management

Firms should be more concerned about working capital adequacy than long-term solvency because, after revealing an insolvency, the latter is of lesser importance relative to the fact that the former, while profitable, has ceased to function. All of these facts underline the importance of efficient working capital management. It has been found that poor management of working capital is one of the major factors for the failure of small-scale units in India. Efficient management of working capital is a very important task of the financial manager. The primary purpose of efficient working capital management is to produce a balance between the risk and returns (profitability) of operations. The financing of working capital acts as a buffer between the non-synchronous cash inflows and outflows. The risk-return position in a firm is influenced to a great extent by the way a firm finances both its short-term and long-term assets. Proper working capital management, keeping the risks in control, can improve both the profitability and liquidity of a firm in the long run.

Due to the nature of their operations, most companies experience higher current liabilities than current assets. These fluctuations in current assets and current liabilities result in working capital management assuming a pivotal position in the overall financial management of an organization. Successful operations may sometimes cause a working capital inadequacy or euphoria through the shortage or excess of funds. From both a risk and profitability basis, the working capital problem is crucial. In contrast to long-term problems which will ultimately be resolved, a firm may collapse if it is not able to solve liquidity problems. Working capital problems are not only faced by currently unprofitable businesses, but profitable businesses often face liquidity problems since profits may not be realized as cash for some time.

4. Strategies for Optimizing Working Capital

The primary strategies for working capital management include improving days sales outstanding (DSO), reducing days sales of inventory (DSI), stretching accounts payable (DPO), optimizing working capital metrics with a particular focus on the Cash Conversion Cycle (CCC), introducing Working Capital KPIs, setting clear responsibilities and targets, and developing structured working capital programs. Optimizing working capital is essential for sustainable long-term business growth. Organizations need to look at ways of unlocking trapped cash within the firm, with working capital management programs closely aligned to strategic goals in order to build sustainable growth over the long term. Organizations with the right working capital metrics and strong discipline around payment terms invariably have lower financing costs which is highly beneficial in today’s challenging economic environment.

Working capital is a financial metric that measures the ability of a business to pay off its short-term liabilities with its short-term assets. Working capital optimization is essential for business growth, as it ensures that the business has the right resources available to capitalize on growth opportunities. Firms with more optimized working capital may even appear fundamentally stronger financially. The basic purpose of working capital is to ensure that a company has sufficient resources available to meet its short-term expenses and operational needs. If the company cannot generate enough working capital to meet its short-term expenses, it may be facing insolvency.

5. Case Studies and Best Practices

This session provides examples of best practices in working capital management drawn from leading organizations around the world. All the companies featured as case studies have achieved impressive results in dynamic business environments, through excellent management of day-to-day operating activities. The strategies adopted by these leading companies – shortening and managing their working capital cycle – show how successful organizations focus their efforts and resources. Also highlighted are some emerging best practices in working capital management, namely the enthusiastic adoption of sophisticated information systems such as SAP, Hyperion Essbase, or Oracle. These applications facilitate web-based interaction with both suppliers and customers, helping to link business operating activities more closely and reducing accounts receivable delinquency and accounts payable hassles.