What is Sales Ratio Method?The sales ratio method is one of the easiest methods of calculating working capital. This method is based on the assumption that “history repeats itself.”Therefore, to determine the working capital in this method, one has to have the past figures of sales in hand.In the sales ratio method, the figure of working capital is determined as a percentage of sales, and the figure is obtained from the past performances of the company. This method is similar to technical analysis of the stock market where past performances of the stock are used to determine the future price ... Read More

Current Assets Holding Period MethodThe current assets holding period method is used to estimate the working capital needs of an organization based on the current assets the company holds. To estimate the working capital needs, the average holding period of the current assets is related to costs based on the firm’s experience in the last year. This method is essentially an operating cycle method.There are a host of factors that affect the working capital calculations. Factors that are most influential includeSeasonal fluctuationsInvestment costsAccurate sales forecastsVariability in sales priceCredit policiesProduction cycleCollection policies.Operating or Working Capital CycleThe operating cycle of a product ... Read More

Trade-off Theory of Capital StructureIn the risk-return trade-off theory of capital structure, there is an optimum level of current assets and/or working capital that a company must maintain to gain the optimum level of profitability. There is another way to look into the risk-return trade-off theory of business companies. It is related to the liquidity of the company.In fact, there are costs of maintaining current assets at a certain level. One of these costs is the cost of liquidity while the other is the cost of illiquidity.Excessive Amount of Current AssetsA company’s level of liquidity will be very high if ... Read More

LiquidityThe liquidity and profitability of a company are directly related to the working capital. When a company maintains high temporary working capital in current assets, it is known to be more liquid. The companies that maintain a lower level of working capital are known as less liquid.Companies that maintain higher liquidity and considered to be at lower risk. They are able to meet the needs of the company and their reservoir of current assets lets them have the freedom to stay solvent.However, more liquid companies have lower profitability because their funds are tied up in operations and these funds cannot ... Read More

Significance of Current Assets over Fixed Assets RatioCompanies need certain levels of current and fixed assets to support a certain level of output. However, in order to support the same level of output, the organization needs to maintain a given level of current assets. The current assets of an organization generally increase with the increase in sales and revenues.In contrast to popular belief, the amount of current assets does not increase proportionally with the output of the companies. The current asset may generally increase with the decrease in output of a company. This theory is based on the assumption that ... Read More

Every business requires a smooth working capital management policy in order to remain in good health and compete with its competitors. The policies a business adopts affect its working capital management norms.For example, the credit policy of the firm and price level changes affect the firm’s financial norms greatly. Here’s how.Effect of Credit Policy On Working CapitalFirms often need to sell their goods in credit to remain attractive to the customers. However, a firm should not be slack in maintaining the credit policy in order to avoid unnecessary delays and missed opportunities. Credit sale creates debtors and managing debtors well ... Read More

What is Net Working Capital Management?The concept of net working capital management should be applied to organizations individually as there is no precise measure to which the net concept of working capital management should be applied to a firm. It depends on the financial status and needs of an organization to which the net concept should be applied to get a holistic solution for managing working capital.Working capital management is related to the management of all aspects of working capital. These aspects are marketable securities, cash, stock, debtors, and creditors. Financial managers must focus their attention on these aspects as ... Read More

Role of Credit PolicyIt is known to all that having a good amount of working capital is necessary for the smooth functioning of businesses. For example, the credit policy of a company plays a pivotal factor in managing the working capital of a company.Companies often need to sell their products on credit to keep and gain market share. It is not possible for all products to get sold instantly which can generate immediate revenues. Therefore, the retailers may ask for a credit to sell the products and then pay for them to the manufacturers.A business company therefore must adhere to ... Read More

What is Operational Efficiency?Operating efficiency is the efficiency that is obtained due to efficient utilization of fixed and current assets and other resources of the firms. It is an indicator of better management and good health of a business firm. Operating efficiency is not easy to obtain because all of the resources of a company must work in tandem to achieve it.Operating efficiency is the use of the resources of the company at the minimum cost. Therefore, it is the optimum utilization of funds at minimal expenses. As the companies strive to utilize all of the resources, the use of ... Read More

Although there are no hard and fast rules for determining the working capital for a company, there are many factors that affect it. It is the duty of management to judge the right amount of working capital for running the organization and keep the adequate amount of working capital available for the firm to stay competitive in the business operations.Factors Affecting Company’s Working CapitalHere are some of the most influential factors that impact the working capital of a company.Nature of the BusinessThe nature of the business influences the working capital to a large extent. Financial and trading firms do not ... Read More