The primary objective of working capital management is to ensure a smooth operating cycle of the business. The secondary objectives are to optimize the level of working capital and minimize the cost of such funds.
The prime objective of financial management is wealth maximization which is achievable by profit maximization with following sustainable growth and development. For sustainable growth and development, the objectives of all the stakeholders, including customers, suppliers, employees, etc., should align with the organization’s growth. Let us see in detail the objectives of working capital management.
Objectives of Working Capital Management
Smooth Working Capital Operating Cycle
This implies that the operating cycle, i.e., the cycle starting from the acquisition of raw material to its conversion to cash, should be smooth. It is not easy; it is as good as circulating 5 balls with two hands without dropping a single one. If the following 6 points, we can learn how to manage the operating cycle well.
- It means raw material should be present in the requirement, and it should not be a cause of stoppages of production.
- All other requirements of production should be in place before time.
- The finished goods should be sold as early as possible once they are produced and inventoried.
- The collection of accounts receivable should b on time.
- Payment of accounts payable when it becomes due without any delay.
- Cash should be available as and when required, along with some cushion.
Lowest Working Capital
Here, working capital refers to the current assets and less current liabilities (net working capital). It should be optimum because higher working capital means higher interest cost, and lower working capital means a risk of disturbance of the operating cycle.
Minimize Rate of Interest or Cost of Capital
To achieve higher profitability, the cost of capital utilized in working capital should be minimum. If the investment in working capital involves bank finance, one should negotiate the interest rates with the bank.
The cost reduction is possible if utilizing long-term funds in a proper mix. One should always keep the fundamental principle of financial management in mind when deciding the mix of working capital. That is, fixed assets and permanent assets should be financed by long-term sources of finance of approximately the same maturity. Similarly, short-term or temporary assets should be financed by short-term sources of finance.
Optimal Return on Current Asset Investment
The return on the investment made in current assets should be more than the weighted average cost of capital to ensure wealth maximization for the owners. In other words, the rate of return earned due to investment in current assets should be more than the rate of interest or cost of capital used for financing the current assets.
Quiz on Objectives of Working Capital Management