Working capital management is a critical component of financial strategy. The seasonal and cyclical fluctuations in the size and pattern of receipts and disbursements of a firm influence the capital requirements of the firm. The working capital requirements are determined through accurate projections of cash flows (ICFAI Center for Management Research ICMR, 2004).
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Liquidity vs. Profitability - The fundametal objective of working capital is to offer adequate support for the undisturbed functioning of the routine operations of a business entity. The question which arises in this situation is the determination of the quantum of investment in working capital that can be regarded as ‘adequate’. Once the fact that a company has to operate in an environment filled with uncertainty or risk is recognized, the term ‘adequate working capital’ comes into picture and it becomes somewhat subjective depending upon the attitude of the management towards the aspects of uncertainty and risk (Blackwell publishing, 2003). Hence, the proportion of investment in the current assets needs to be invested in such a way that it not just meets the needs of the forecasted sales but also offers a built-in bolster in the form of safety stocks in order to meet unpredicted contingencies cropping out of elements like delays in the arrival of raw materials, sudden shots in the sales demand etc., and many other similar issues. As a consequence to the above, the investment in current assets for a given level of forecasted sales will be much higher if the management adapts a conservative attitude rather than an aggressive attitude. Thus, a company that adapts a conservative attitude is subjected to a lower risk than a firm that adapts an aggressive approach. The objective of working capital management covers not only the management of current assets in tune with the attitude of management toward risk and arriving at a satisfactory level of current assets that balances the liquidity and profitability criteria but also the management of financing the chosen level of current assets once again taking into consideration the attitude of risk management.
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