Whatever funds are raised by a company, can be applied for two purposes:

1.    To acquire fixed assets, the technical terminology used being Capital Budgeting.
2.    To invest in the current assets, technical terminology used being

Working Capital Management.

Working capital management is considered one of the most important functions of finance, as a very large amount of funds are blocked in current assets in practical circumstances. Unless working capital is managed properly, it may lead to the failure of business.

The term “Working Capital” may mean Gross Working Capital or Net Working Capital. Gross Working Capital means Current Assets. Net working Capital means Current Assets less Current Liabilities. Unless otherwise specified, Working Capital means Net Working Capital. As such, Working Capital Management refers to proper management of Current Assets and Current Liabilities.

The term current assets refers to those assets, which can be transformed in the form of cash or used during the course of normal operations within a short span of time say one year, without any reduction in value. Current assets change the shape very frequently.

The current assets ensure smooth and fluent business operations and are considered to be life-blood of the business. In case of a manufacturing organization, current assets may be found in the form of stocks, receivables, cash and bank balances and sundry loans and advances.

The term current liability refers to those, which are to be paid off during the course of business, within a short span of time say one year. They are expected to be paid out of current assets or the earnings of the business. Current liabilities consist of sundry creditors, bills payable, bank overdraft or cash credit, outstanding expenses, etc.

Principles of Working Capital Management

The basic objective of Working Capital Management is to avoid over investment or under investment in current assets, as both the extremes involve the adverse consequences.

Over investment in current assets may lead to the reduced profitability due to cost of funds blocked, extra storing space required, possibility of malpractice, etc. The objective of Working Capital Management is to ensure Optimum Investment in Current Assets.