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Explain the Types of Working Capital Management and its Policy

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The operational efficiency of a business can be directly attributed to the presence of its working capital. By efficient functioning, it means to ensure that the company puts its best foot forward in managing its current assets and liabilities. That helps reap the most fruitful benefits and ensure smooth operation in its business, which leads to greater profitability in business activities. This is termed as working capital management.

The prime focus is to strike the right balance between current assets and current liabilities, thereby having the leverage to access the required funds in order to meet financial requirements. Though you can avail a working capital loan to strengthen your business, it is important you have a hold on grassroots of your business activities as well.

How to efficiently manage working capital?

The short term liquidity of a firm is of utmost importance while you look for ways to avoid mistakes when managing your working capital. This liquidity is expected to meet your regular financial expenses and they need to be managed effectively to ensure hassle-free business operation.

As a businessman, he/she needs to make sure the following ratios are maintained stringently, which are directly responsible to facilitate a smooth working capital cycle –

  • Working capital ratio

This ratio determines the capability of a business to meet its financial needs. Generally, a ratio of 1.5 to 2 is considered stable for a company and signifies its strong finances and effective working capital management.

  • Inventory turnover ratio

This ratio indicates the capability of a company to manage its inventory and thereby generate sales out of the same.

  • Collection period ratio

This ratio is indicative of the capability of a business to liquidate its debts. The faster it can convert debts into the inflow of funds, the better it is at increasing its working capital. 

What are the policies in managing working capital?

For effective working capital management, a business needs to abide by some working capital policies. Those working capital policies are categorically divided into three broad strategies –

  1. Relaxed policy

Uncertain events like an abrupt change in sales, seasonal ups and downs, and many more are carefully analysed before the estimation of current assets. This policy results in averting most of the risks that a business might come across.

  1. Moderate policy

This policy considers risks that are less damaging than the restricted policy but more than relaxed policy. It acts as a balance between the two policies, because of which, the working capital management regarding moderate policy is considered at a medium level along with its profitability.

  1. Restricted policy

It is the most stringent policy among the three, which involves no prior consideration of unforeseen events or fluctuations. The estimation of current assets is carefully made, negating every contingency. Hence the associated risk is also comparatively higher, unlike the other two policies.

Monitoring and maintaining the working capital demands substantial consideration and financial backing. Alternately, you can also avail business loans from reputed lenders that offer credits at attractive interest rates. You can easily meet your current monetary needs for working capital management while repaying the due amount within the repayment tenor.

To ensure hassle-free conduct of business activities, it is important to have the right balance between income and expenditure. Successful working capital management is thus a significant aspect of running a business successfully.

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