Q. Objectives of working capital management?
The objectives of working capital management are habitually stated to be profitability and liquidity. These objectives are habitually in conflict since liquid assets earn the lowest return and so liquidity is achieved at the expense of profitability. Nevertheless liquidity is needed in the sense that a company must meet its liabilities as they fall due if it is to remain in business. For this reason cash is habitually called the lifeblood of the company since without cash a company would quickly fail. Good working capital management is consequently necessary if the company is to survive and remain profitable.
The basic objective of the company is to maximise the wealth of its shareholders and good working capital management helps to achieve this by minimising the cost of investing in current assets. Good credit management for instance aims to minimise the risk of bad debts and expedite the prompt payment of money due from receivables in accordance with agreed terms of trade. Taking steps to optimise the level as well as age of receivables will minimise the cost of financing them leading to an increase in the returns available to shareholders.
An alike case can be made for the management of inventory. It is probable that Velm plc will need to have a good range of stationery and office supplies on its premises if customers' needs are to be quickly met and their custom retained. Superior inventory management for example using techniques such as the quantity model, economic order, ABC analysis and inventory rotation and buffer inventory management can minimise the costs of holding and ordering inventory. The application of just-in-time processes of inventory procurement and manufacture can reduce the cost of investing in inventory. Taking steps to get better inventory management can therefore reduce costs and increase shareholder wealth.
Cash budgets is able to help to determine the transactions need for cash in each budget control period although the optimum cash position will as well depend on the precautionary and speculative need for cash. Cash management models such like the Baumol model and the Miller-Orr model can help to maintain cash balances close to optimum levels.
The dissimilar elements of good working capital management therefore combine to help the company to achieve its primary financial objective.