Impact of Recession on Working Capital Requirements of a Company

Topics: Inventory, Working capital, Cash conversion cycle Pages: 4 (1098 words) Published: October 18, 2012
Impact of Recession on Working Capital Requirements
of a Company

Working Capital Management is a managerial accounting strategy focusing on maintaining efficient levels of both components of working capital, current assets and current liabilities, in respect to each other. Working capital management ensures a company has sufficient cash flow in order to meet its short-term debt obligations and operating expenses.

Implementing an effective working capital management system is an excellent way for many companies to improve their earnings. The two main aspects of working capital management are ratio analysis and management of individual components of working capital. Ratio analysis will lead management to identify areas of focus such as inventory management, cash management, accounts receivable and payable management.

Working capital theory prescribes using the optimal amount of net working capital to maximize shareholder wealth. Evidence from multiple countries indicates a negative relationship between the cash conversion cycle or net working capital and firm profitability. However, severe economic conditions may force firms to change their inventory, accounts receivable, and/or accounts payable policies, causing the firms to use more/less net working capital. Also, it appears firms in general held more net working capital in order to face new economic challenges. Most businesses like to plan ahead mainly focusing on setting targets and monitoring performance for sales growth, cost control and profit improvement; however the Management of Working Capital is often missed from the plan. In these times of credit crisis, trying to monitor and improve sales and profit performance may be difficult and suddenly Working Capital becomes vital.  Yes, it is still important to control costs, but if the business is experiencing falling demand for its products and services, or pressure to lower prices, then “Cash is King” and the importance of control over working...
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