Working capital management is an important component of overall financial management. Management of working capital like long-term financial decisions affects the risk and profitability of business. In business two types of assets are used.
Fixed Assets include land, building, plant and machinery, furniture and fittings etc. fixed assets are used in the business for a long period and they are not purchased for the purpose of selling them to earn profit.
Current Assets, on the other hand, are used for day to day operation of business. For the efficient and effective use of fixed assets, there should be adequate working capital in the business. Current assets include cash, bank stock debtors, bills receivable, marketable securities etc. the capital employed in these assets is called working capital. In any business, there should be proper balance between fixed capital and working capital.
The problem relating to management of working capital is different from that of management of fixed assets. Fixed assets are purchased for long term use in business and the return on them is received during their lifetime. On the other hand, current assets get converted into cash in short term. One more significant characteristic of the current assets is that, if the amount of current assets is more in a business, it will increases the liquidity but profitability will reduce. On the other hand, if current assets are relatively lesser, profitability will improve but liquidity will be adversely affected. Therefore, the main objective of working capital management is to determine optimum amount of investment in current assets so that balance in profitability and liquidity of the business could be ascertained.