The following work analyzes the problems of the administration of the resources of the company, which are fundamental for its progress.
Specifically, it focuses its objectives on showing the key points in the management of Working Capital, since it is this that largely measures the solvency level, while ensuring a reasonable margin of safety for the expectations of managers and administrators.
Therefore, it is necessary to achieve maximum efficiency in it in order to guarantee the long-term success of the company, thus achieving its total objective. For these reasons, companies begin to attach importance to the dynamics of their Working Capital and the behavior of their structure, controlling the undue increase in accounts and receivables, accounts payable and inventories; elements that affect entities with greater sensitivity.
Origin and need of Working Capital
Weston, (1994) in "Fundamentals of Financial Administration" states that the term Capital originated "with the legendary American pacotillero, who used to load his car with numerous goods and travel a route to sell them.
This merchandise received the name of Working Capital because it was what was actually sold, or what was rotated along the way to produce profits ”(1).
Another of the criteria on the origin of Working Capital is the one that according to the site datos.lycos, (2004)
“The term Labor capital originated as such at a time when most of the industries were closely linked with agriculture; processors bought the crops in the fall, processed them, sold the finished product, and finished before the next harvest with relatively low inventories.
Bank loans with maximum maturities of one year were used to finance both the cost of purchasing raw materials and those of processing, and these loans were withdrawn with the funds from the sale of the new finished products ”(2).
Both the origin and the need for Working Capital reside in the environment of the company's cash flows, which can be predictable; Both are also based on the knowledge of the maturity of the obligations with third parties and on the credit conditions with each one.
Although it is worth adding that what is really essential and complicated is the prediction of future cash receipts; since assets (such as accounts receivable and inventories) are items that, in the short term, are difficult to convert to cash.
The foregoing shows the fact that, the more predictable future cash inflows are, the lower the Working Capital required by the company.
Net Working Capital or Maneuver Fund
According to Weston, (1994) in his book "Fundamentals of Financial Administration", Net Working Capital is defined as "the difference between current assets and current liabilities of a company" (3).
In the salonhogar site, 2004 it is said that "Working capital is the excess of current assets over the liability accounts, which constitute the immediately available working capital necessary to continue the operations of a business" (4).
In fact, Working Capital is nothing more than a company's investment in short-term assets (cash, marketable securities, accounts receivable and inventories). As long as the assets exceed the liabilities, the company will have Net Working Capital.
Almost all companies operate with an amount of this nature, which depends, to a large extent, on the type of industry to which it belongs.
Companies with predictable cash flows, such as electrical services, can operate with a negative Net Working Capital, although most companies must maintain positive levels of it.
The management of Working Capital is extremely important, since the current assets of a typical industrial company represent more than half of its total assets. In the case of a distribution company, these assets represent even more.
For a business to operate efficiently, it is necessary to carefully monitor and control accounts receivable and inventories.
In the case of a fast growing company, this is very important, because investment in these assets can easily get out of control.
Excessive levels of current assets can cause the company to obtain a below-standard return on investment.
However, companies with low levels of current assets may incur deficits and difficulties in maintaining stable operations.
Gitman, (1986) in "Fundamentals of Financial Administration" states: "… the larger the amount of existing assets, the greater the probability that some of them can be converted into cash to pay an overdue debt…" (5)
Working Capital management encompasses all aspects of it, which requires an understanding of the interrelationships between current assets and current liabilities, and between Working Capital, capital, and long-term investments.
According to Peñate, (2004): “The administration of Working Capital is particularly important for small companies.
Although these companies can minimize their investment in fixed assets by leasing plants and equipment, they cannot avoid investing in cash, accounts receivable and inventory.
Furthermore, because a small company has limited access to long-term capital markets, commercial credit and short-term bank loans, which affect working capital, must be used solidly, increasing current liabilities ”(6).
The target of this type of management is to manage each of the company's short-term assets and liabilities, so that an acceptable and constant level of Net Working Capital is reached.
According to Horne, (1994) in »Fundamentals of Financial Administration”: «… the determination of the appropriate levels of current assets and liabilities serves in setting the level of working capital, and includes fundamental decisions about the liquidity of the company and the composition of the maturities of your debt.
In turn, these decisions are influenced by a compromise between profitability and risk… "(7).
Profitability vs. Risk
To determine the correct form, or the optimal level of current assets, management must take into account the interaction between profitability and risk.
In general, it is said that the higher the risk, the higher the profitability; This is based on the management of Working Capital at the point that the profitability is calculated by profit after expenses against the risk determined by the insolvency that the company possibly has to pay its obligations.
A concept that is gaining momentum is how to obtain and increase profits. The theory indicates that to obtain an increase in these, there are two essential ways; the first, increasing income through sales; second, by reducing costs by paying less for raw materials, wages, or services provided.
This postulate is essential to understand how the relationship between profitability and risk is linked to that of effective management and execution of Working Capital.
According to Gómez, (2004) "The greater the amount of the working capital of a company, the lower the risk that it is insolvent" (8); fact that is based on the relationship between liquidity, working capital and risk: if they increase the first or the second, the third decreases in an equivalent proportion.
Usually used as a risk measure, the insolvency of the company, the more solvent or liquid it is, the less likely it is that it will not be able to meet its debts at maturity.
If the level of Working Capital is low, it will indicate that its liquidity is insufficient; therefore, such capital represents a useful measure of risk.
The higher the ratio or ratio of current assets to total, the less profitable the company will be and therefore less risky. Or, the higher the ratio of current liabilities to total assets, the more profitable and riskier the company will be.
Since Net Working Capital can be considered as part of the current assets of a company, financed with short and long-term funds, it is directly associated with the return-risk ratio and Net Working Capital.
Therefore, there are two functions that Net Working Capital fulfills: one, economic; another, financial.
In its economic function, it can be considered as complementary and heterogeneous production goods that contribute to the creation of products and services by the company.
It is complementary insofar as they are necessary together with capital goods for the development of production; It is heterogeneous since it is made up of diverse components with different degrees of liquidity.
As the company permanently needs Working Capital (current resources), it must be financed with some stability (in the long term) in order to guarantee financial balance.
On the other hand, in its financial function, it must guarantee the adequacy between the liquidity rates and the enforceability of assets and liabilities. This adaptation guarantees solvency and, based on this, two basic rules are established:
1.- All fixed assets must be financed by permanent resources, that is: Long-term liabilities plus Capital (minimum financial balance rule).
2.- The permanent liability must be higher than the fixed asset, or what is the same, that the Net Working Capital must be positive (security rule).
Having considered the previous points, it is necessary to analyze those key points to reflect on the correct administration of working capital in the face of maximizing profit and minimizing risk.
- Nature of the company: It is necessary to locate the company in a context of social and productive development, since the development of the financial administration, in each one, is of different treatment. Asset capacity: By nature, companies always seek to depend on their fixed assets in a greater proportion than on current assets to generate their profits, since the former are the ones that actually generate operating profits. Financing costs: Companies obtain resources through current liabilities and long-term funds, the former being cheaper than the latter.
Uses and applications of Net Working Capital
The main uses or applications of working capital are:
- Declaration of cash dividends. Purchase of non-current assets (plant, equipment, long-term investments in commercial securities.) Reduction of long-term debt. Purchase of outstanding capital shares. Spontaneous financing. Commercial credit, and other accounts. payable and accumulations, which arise spontaneously in the daily operations of the company. Protection approach. It is a financing method where each asset would be compensated with a financing instrument of approximate maturity.
In the article “The State of origin and application of funds”, Gómez, 2004 states that “The State of origin and application of Working Capital is very similar to the State of origin and application of cash, except that changes in assets and Current liabilities are not given separate entry, instead they are consolidated into a single item that corresponds to the change in working capital ”(9).
In El prisma (2004) it is stated that “The use of Net Working Capital in the use of funds is based on the idea that available current assets, which by definition can be converted into cash in a short period, can be used in this way same to the payment of present debts or obligations, as is usually done with cash ”(10).
There are several approaches or methods to determine an adequate financing condition.
- The dynamic approach is a high-profit, high-risk financing plan, in which the temporary requirements are financed with short-term funds, and the permanent, with long-term funds. The conservative approach is a low-profit financing plan. - low risk; All funding requirements (both temporary and permanent) are financed with long-term funds. Short-term funds are held for emergencies. Most companies employ an alternative method of exchange in which some temporary requirements are financed with long-term funds; This approach falls between the dynamic high profit-high risk approach and the conservative low profit-low risk approach.
Conclusions
Consequently, the administration of Working Capital has variables of great importance, which have been analyzed quickly but precisely, each of them are a key point for the administration performed by managers, directors and those in charge of financial management..
Therefore, it is pertinent, then, to take the maximum measures necessary to determine a financial capital structure where all current liabilities efficiently finance current assets and determine optimal financing for the generation of profit and social welfare.
