Role of Working Capital in a Firm

Working capital plays a significant role in the management of a company’s resources. Companies that are making losses might have been profitable if they found a way to manage their working capital more efficiently. Working capital is important for a business in the following ways:

  • Determining Liquidity of the Firm: managers calculate working capital to determine whether the firm has sufficient liquid assets that can easily be turned into cash to pay off financial obligations as they fall due.
  • Promoting Efficiency: Having a positive working capital ensures that the company can operate normally and more efficiently. Without cash, the company may experience delays in payments, customer complaints, and other operational issues.
  • Enhancing good cash flow: working capital ensures that the firm has a positive cash flow where incoming cash is higher than cash outflows. Having a positive working capital means that the firm has enough cash to use in daily business operations.
  • Expansion/growth: working capital can be used to achieve business growth. For example, having enough cash and inventory enables the firm to expand to new markets and sell more products in existing markets. In this case, working capital can be used as a source of finance for investment and expansion purposes.
  • Increased Profits: Working capital management enables a company to increase its profitability. This can be done by saving on financial costs that could have been incurred if there was no working capital to pay off current liabilities.
  • Availability and Proper Utilization of Resources: Working capital ensures that the company has sufficient cash to acquire resources and maintain existing resources. For instance, maintaining an optimal level of stock ensures that the company can meet demand at all times. There must be enough cash to purchase new stock when the current stock is depleting, and to maintain motor vehicles and equipment.
  • Promotes the company’s going Concern: a going concern is a situation in which a business has a good financial health and can be able to meet its obligations and continue operating for a long time into the foreseeable future. Without sufficient resources, the company can easily go out of business and lose its going concern. Working capital enables the company to continue operating for a longer period in the foreseeable future.
  • Promotes Positive Stakeholder Relations: a company with a positive working capital is able to satisfy its stakeholders such as customers, suppliers and shareholders. For instance, having enough working capital means that the firm can pay its suppliers and creditors on time; hence improving relationships with those stakeholder groups.

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