Working capital, or total current assets minus total current liabilities, refers to the additional current assets that a company holds on its balance sheet as a liquidity cushion. M🌠ost current assets are funded by current liabilities and are expected to be converted back to c🐲ash within 12 months for payments on current liabilities due in the same cycle.

Certain current assets may become illiquid at the time when cash is needed to meet short-term obligations, including inventory without a ready market. When avoiding liquidity issues that may hamper a company's financial strength, it is financially sound to maintain a certain amount of 澳洲幸运5官方开奖结果体彩网:working capital so 🌊bills are paid on time; however, maintaining a working capital that is too high is inefficient. Below are some of the advantages of maintaining a low working capital.

Increasing Investment Effectiveness

Deploying working capital can be a double-edged sword: it ensures liquidity but also ties up capital that could have been better invested elsewhere. Because working capital is the amount of 澳洲幸运5官方开奖结果体彩网:current assets in excess of the amount of 澳洲幸运5官方开奖结果体彩网:current liabilities, it is funded by long-term ca🐠pital raised for investment purposes rather than operational maneuvers.

When investment capital is allocated away for short-term uses, it potentially reduces a company's investment effectiveness. As long as liquidity concerns are adequately addressed, low working capital is desired to ensure the effective use of long-term funds.

Improving Operational Efficiency

The amount of working capital required for each operating cycle is dependent on a company's 澳洲幸运5官方开奖结果体彩网:operational efficiency. For example, the more a company can ma൲ke in cash sales or the faster it can turn over inventories, the lower the amount of working capital it needs.𓄧

When a company maintains a low level of working capital, it can force itself to improve its operating efficiency so operating cash flows, coupled with additional working capital, can 澳洲幸运5官方开奖结果体彩网:safely cover costs and expenses during operations. With too much fundin♚g tied up idly in working capital for liquidity backup, a company may become less concerned about operating efficiency.

Shortening the Cash Conversion Cycle

Even wi♐th a low level of working capital, companies can still have sales on credit if they try to make the collection process as short as possible. The sooner accounts receivable are converted to cash, the less working capital is required. Inventories also potentially tie up funds for long periods.

In addition to raw materials, finished products can remain unsold for some time, which further lengthens the cash conversion cycle. If a company wishes to maintain a low level of working capital✱, sales must be made prompt🔴ly after production, so funds stay within the cash conversion cycle for as little time as possible.

On-Demand or Just-in-Time Operations

Working capital can be reduced to as close to zero without jeopardizing a company's ability to meet short-term obligations if the so-called on-demand or 澳洲幸运5官方开奖结果体彩网:just-in-time (JIT) operations can be adopted. Under such an operating regime, a company holds little or no inventories of unused raw materials and unsold finished products. By having little or no funds parked🐟 in potentially illiquid assets, a company effectively deploys little or no working capital.

A company can achieve this stance by working in unison with raw materials suppliers in the supply chain and sales distributors in the distribution network. In other words, a🐼 company does not purchase inventory until it is needed for production or produce anything unless sales orders are received. This way, funds designated for working capital are released and put into more productive uses.

Working capital is necessary to ensure uninterrupted operations, but it does not contribute directly to revenue generation or profitability. On the contrary, having too much working capital may hinder a company's financial results when the funds sit idle until a liquidity need arises.

Suppose a company can maintain a low level of working capital without incurring too much liquidity risk. In that case, this level benefits a company's daily operations and long-term capital investments. Less working capital can lead to more efficient operations and more funds available for long-term undertakings.

The Bottom Line

Having a 澳洲幸运5官方开奖结果体彩网:certain level of working capital is crucial to the financial health of a company. It allows companies to meet sꦿhort-term obligations and maintain a certain level of liquidity whenever cash is needed. Maintaining too high a level of working capital, however, is inefficient, as a company can miss out on investment returns and improvements in operational efficiency.