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What is working capital? What could happen if an organization neglected to manage its working capital?

Working capital is defined as “The firm’s total investment in current assets or assets that it expects to be converted into cash within a year or less”

Management of working capital includes consideration for net working capital, by managing current assets to current liabilities. This means organizations have to factor in a certain amount of risk-return trade-offs in the decision making process. If an organization does not increase their net working capital enough, they run more of a risk of struggling to pay their bills. But if they increase the working capital too much, they are taking away from the profitability of the organization. In order to avoid problems, organizations have to make good decisions which overlap, between current assets and how current liabilities are used.

Working capital techniques

The organization I work for would be best using different methods for different departments. With our production lines and factories, it would be a risk to rely completely on using liabilities to finance working capital, because the life of a product and production volumes, while forecasted, tend to fluctuate and sometimes to extremes. So for that structure, the hedging principle would most likely be a better fit, and introduce less risk. However, for functions like our R&D sites, or corporate offices, since those are stable sites with consistent functions and needs, using liabilities to finance working capital would be a reasonable option with fairly minimal risk.

 

 


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