Fixed assets are essential to run the business, but it does not directly contribute towards satisfying customers. Many of the fixed assets are not product specific, and could also be put to altogether different types of uses. Any fund not “sunk” into fixed assets is available for the “real business” of making profit. Fixed assets should be regulated to essential minimum requirements to optimise application of available funds. Working Capital The value of Current assets, together with retained cash and the money due from customers is known as working capital.
The disposition of the available funds into fixed assets and working capital can be diagrammatically represented as below: Working capital management Application of funds for working capital, irrespective of the constitution of the operating entity, requires very careful management. Options available to different types of entities depend more on the strength of each entity, its customer base and acceptance, than the structure of the entity. Given good market acceptance and stable performance, differences between the structures of organisations will not make any significant difference in working capital management.
In other words, there is no difference between the principles of working capital management in a Sole Trading firm, a Partnership firm or a Company. A limited liability company to some extent has better options when compared to a Sole trader or Partnership firms in raising funds in times of need. The elements of working capital management are to be examined to appreciate this point. In an ongoing situation, the following are the elements of working capital: • Stocks • Work in progress • Debtors • Expenses paid in advance • Creditors
Each of the above elements entails judicious management of available cash. The first four elements represent outflow of cash. It is essential to minimise these outflows as appropriate to the volume of business. The fourth one represents latent inflow. Management efforts to regulate the various elements are described below. Stocks Stocks can be in the form of input materials or as finished products. Carrying too much of stocks will block funds that could otherwise be used more effectively. Excess stocks result in increased cost of storage and handling.
On the other hand decreased stock of inputs can lead to interruptions in operations adversely affecting product flow and sales. Increased level of finished products in excess of the demand, leads to inefficient use of funds. Therefore input stocks and output stocks have to be maintained at optimum levels. As the name implies, work in process represents product held at different stages of production. Processes and operations should be devised in such a manner that the work in progress is minimised.