Working capital management is an easy understandable concept, since it pertains to the expense of living, which is measured in a very personal way and therefore can be easily understood on an individual basis. It is the most basic way to manage a business. Working capital has been a common metric for the effectiveness, liquidity and the overall health of an enterprise. However, in order to successfully manage working capital, a corporation needs to have a good understanding of what it is and how it works.
The term working capital pertains to the funds an organization has available for short-term needs. These funds are usually kept in two main categories: long-term and short-term. A working capital management plan is designed to meet both needs and budgets. The most common method used for managing these funds is by establishing a balance between long and short-term needs.
Assets are those that an organization owns or controls. Assets include items like furniture, machinery, equipment, fixtures, inventories and other tangible assets. Assets are used for short-term expenses such as supplies and materials, salaries, and advertising. When used for long-term expenses such as purchasing raw materials and paying for inventories, these assets are called long-term assets. Long-term assets are also known as fixed assets.
Liabilities are those assets which are owed to another person or organization. Liabilities are usually used to pay for goods or services that an entity is unable to sell itself, but still owes another party money. Fixed assets are not used to pay other people, but rather are held for use.
In the case of fixed assets, management is based upon how much income the firm makes. If the firm is not making enough money to cover its expenses, management is used to increase income through the borrowing of funds. For example, if the firm is spending money on raw materials to make a new item and is not making enough income from the sale of that item, management is used to borrow the funds needed to produce the new product. Management is also used to pay for items such as salaries, for purchasing inventories and for paying suppliers.
There are different forms of working capital management, but all of them are used to meet short-term expenses. These expenses include expenses for materials to produce an item, expenses to pay salaries, and for expenses incurred during the inventory cycle. when the firm needs to purchase an item and when it needs to replenish an item that it does not have in stock. Other expenses that need to be addressed include payments made to vendors that are related to the manufacturing process, and payments made to customers that are related to the supply chain.