The zero risk category does not exist. All financial decisions made by company managers positively or negatively affect liquidity and performance. From the above, two issues of working capital management are: maximize profitability and minimize risk. However, both are directly proportional. The purpose of this article is to define the components of the risk-return binomial and the impact that different levels of working capital cause on it. To illustrate the above, two demonstrative examples are included based on the real information of two hotel facilities.
Development
The term working capital has been named by some authors as: working capital, working capital, net working capital, resource or net revolving fund and net cash. In general, this can be defined as investment in current asset levels and the financing that is needed to sustain it.
working-capital-and-its-relationship-with-risk-and-business-performance-demonstrative-exampleCompany managers must make daily decisions of all kinds that have a direct implication in finances, so that they affect positively or negatively the degree of liquidity and performance (F. Weston and E. Brigham, 1994). It is for this reason that financial managers define two fundamental objectives of working capital management:
- maximize profitability, minimize risk.
However, both objectives are directly proportional, which means that when one of the variables increases, so does the other, and vice versa.
Once the previous elements have been introduced, it is necessary to define the components of the risk-return binomial.
In this context, Van Horne and Wachowicz (1997) define the return as the income received on an investment, which is generally expressed in percent, while F. Weston and E. Brigham (1994) generalize it interchangeably as the flow current. of cash and rate of return on assets. For their part, L. Gitman (1986) and GE Gómez (2004) consider profitability as profit after expenses. These researchers agree that by theoretical foundation this is obtained and increased in two essential ways: the first, increasing income through sales and the second, reducing costs by paying less for raw materials, wages, or services provided. The author is more inclined to the analysis of profitability in the form of a rate, indicating the ability of resources to generate profits,as a more effective avenue for analyzes related to working capital levels and their influence on business profitability.
For its part, the risk category in its definition is assimilated with greater difficulty (Van Horne and Wachowicz, 1997). In very simple terms, there is a risk in any situation where it is not known exactly what will happen in the future. Risk is synonymous with uncertainty, which is the difficulty of predicting what will happen in the future.
In financial management, risk is associated with the variability of the expected results (Van Horne and Wachowicz, 1997), deriving from this that what offers more variable results, whether positive or negative, is more risky. With respect to the analysis of risks in a business, three fundamental ones can be identified to be evaluated: commercial risk, financial risk and operational risk.
Commercial risk is inherent to the market in which the company operates, where analysis of the business line, the branch in which it operates and the economic-financial environment are vital. Operational risk is linked to the optimal dimensions of plants and equipment, the use of resources and the relationship with sales levels; that is, the conditions of technology. Financial risk is related to the level of indebtedness and the relationship between external and own financing; that is, the analysis related to the financial structure.
Linked to working capital, risk means danger for the company due to not having enough current assets to:
- Deal with your cash obligations as they occur. In this sense, L. Gitman (1986) defines risk as the insolvency that the company may have to pay its obligations and also expresses that the risk is the probability of being technically insolvent.Supporting the appropriate level of sales (Van Horne and Wachowicz, 1997). Cover the expenses associated with the level of operations (criterion of the author of the article based on the reviewed literature).
In this context and as one of the ways to measure the risk resulting from the changes caused by the decisions made by the financial managers, the solvency or general liquidity ratio is proposed:
General liquidity =
This reason refers to the ability that a company acquires to have availability of assets that are easily converted into cash, reaffirming its ability to cover its short-term financial obligations in a timely manner and without delay (E. Gómez, 2004).
It is important to note that in this framework this reason is proposed for risk assessment, but there are other ways proposed by the author and which are explained in detail in her Thesis presented as an option to the scientific degree of Master in Economic Sciences (Universidad de Matanzas, 2005). These alternatives are shown below:
Figure 1: Alternative ways to measure the risk associated with working capital management.
Source: Espinosa, Daisy. Proposal for a procedure for the analysis of working capital. Hotel case. Thesis presented as an option to the scientific degree of Master in Economic Sciences, directed by Dr. Nury Hernández de Alba Álvarez. University of Matanzas, 2005.
Having considered the above definitions, it is necessary to analyze the key points to reflect on a correct analysis of working capital against the maximization of profitability and the minimization of risk, on which authors such as L. Gitman (1986), F. Weston and E. Brigham (1994) and GE Gómez (2004) and Munilla (2005), agree that these are:
- The nature of the company, being necessary to locate it in a context of social and productive development, since the financial administration in each one is of different treatment. Likewise, it is important to highlight that the company is a subsystem of the society system and as such, maintains an interdependent relationship with its other subsystems. The capacity of assets in generating profits, emphasizing the mix of currency and fixed and ensuring the time that each of them needs to advance to the form of cash. Financing costs, since companies obtain resources through current liabilities and long-term funds, where the analysis of the economic, associated with the different decision alternatives is essential.
Figure 2: Risk-return intercompensation in relation to working capital.
In summary, a financial manager should look for that particular equilibrium point between the risk and the profitability derived from the different decisions that imply variations in the working capital, as shown in Figure 2. This equilibrium point is called intercompensation. risk - return.
Practical example
A company shows for two consecutive periods the following summary balance sheet and the net result achieved for both.
| Accounts (pesos) | Period 1 | Period 2 |
| Current assets | 2320121.14 | 1938 304.23 |
| Fixed assets | 12764242.99 | 13042131.58 |
| Other assets | 34 990 8,46 | 294,552.63 |
| Total Assets | 15434272.59 | 152,74988.44 |
| Current liabilities | 557648.73 | 963213,83 |
| Long-term liabilities | 360 404.63 | 399 802.81 |
| Heritage | 14,516,219.23 | 13911971.8 |
| Total Financing | 15434272.59 | 152,74988.44 |
| Net result | 24,485.49 | 52,457.07 |
A very general analysis of variations in current accounts from one period to another shows the following:
| Accounts (pesos) | Period 1 | Period 2 | Variation |
| Current assets | 2320121.14 | 1938 304.23 | -381 816.91 |
| Fixed assets | 12764242.99 | 13042131.58 | 277 888.59 |
| Other assets | 34 990 8,46 | 294,552.63 | -55355.83 |
| Total Assets | 15434272.59 | 152,74988.44 | -159284.15 |
| Current liabilities | 557648.73 | 963213,83 | 405 555.10 |
| Long-term liabilities | 360 404.63 | 399 802.81 | 39398.18 |
| Heritage | 14,516,219.23 | 13911971.80 | -604,247.43 |
| Total Financing | 15434272.59 | 152,74988.44 | -159284.15 |
| Net result | 24,485.49 | 52,457.07 | 27,971.58 |
As can be seen, the decisions made regarding the management of current accounts indicate:
- a decrease in current assets of 381 816.91 pesos, an increase of 405 565.10 pesos in current liabilities, and an increase in net income of 27971.58.
Theoretically, these results should lead to:
- an increase in risk due to the fact that the decrease in current assets and the increase in current liabilities entails a decrease in the ratio of general liquidity or solvency, increasing the possibilities of defaulting on corporate obligations, an increase in profitability due to the risk and profitability are directly proportional.
In a practical way, these expected results can be verified, which are summarized in the following table:
| Indicators | Unit of measurement | Period 1 | Period 2 | Variation |
| Solvency or General Liquidity | pesos | 4.16 | 2.01 | -2.15 |
| Total asset return | % | 0.16 | 0.34 | 0.18 |
| Yield on current assets | % | 1.06 | 2.71 | 1.65 |
| Yield of fixed assets | % | 0.19 | 0.40 | 0.21 |
Indeed, the expected results are ratified:
- The risk increases because the Solvency or General Liquidity index decreases considerably from 16 to 2.01 pesos of current assets for each peso of short-term liabilities, indicating that the company's ability to cover its current obligations has decreased by 52% (1- (2.01 / 4.16) * 100). Profitability increases because the return on assets: total, current and fixed increases; that is, the ability of the company to generate a positive net result for each peso of each category of asset is greater, increasing by 116%, 156% and 110% respectively.
Notwithstanding the foregoing, the decisions made in the second period are considered favorable, since even when the risk increases, the company is still in comfortable conditions to face its short-term obligations with current investment; in addition to increasing the profitability of business investment.
In the analysis of another example, it is observed how the intelligent decisions made regarding the way in which current assets are financed with current liabilities, can lead to positive results, achieving a compensation between the elements of the alternative risk - cost effectiveness.
| Accounts (pesos) | Period 1 | Period 2 |
| Current assets | 1938 304.23 | 1894 293.84 |
| Fixed assets | 13042131.58 | 129,70811.56 |
| Other assets | 294,552.63 | 369 470.05 |
| Total Assets | 152,74988.44 | 15234575,45 |
| Current liabilities | 963213,83 | 706 449.41 |
| Long-term liabilities | 399 802.81 | 646 426.84 |
| Heritage | 13911971.80 | 13881699.20 |
| Total Financing | 152,74988.44 | 15234575,45 |
| Net result | 24,485.49 | 165,279.51 |
| Indicators | Unit of measurement | Period 1 | Period 2 |
| Solvency or General Liquidity | pesos | 2.01 | 2.68 |
| Total asset return | % | 0.16 | 1.08 |
| Yield on current assets | % | 1.26 | 8.73 |
| Yield of fixed assets | % | 0.19 | 1.27 |
As can be seen, the variations that have taken place in the current accounts have caused a decrease in the risk of not being able to meet current obligations, since the solvency index has increased by 33%, while the profitability of total assets It has increased fivefold, increasing the company's ability to generate positive results from the exploitation of its resources.
In conclusion, a company can make decisions that maintain favorable risk results; that is, acceptable levels by managers. Likewise, these results can also be combined to achieve high levels of profitability of its resources.
Bibliography
- Espinosa, D. Proposal for a procedure for the analysis of working capital. Hotel case. Thesis presented as an option to the scientific degree of Master in Economic Sciences, directed by Dr. Nury Hernández de Alba Álvarez. Universidad de Matanzas, 2005. Gitman, L. Foundations of Financial Administration. Special edition. Ministry of Higher Education. Cuba, 1986. Gómez, GE Administration of working capital. Consulted in March 2005. Available at: http://www.gestiopolis.com/canales/financiera/articulos/no%205/administracioncapitaltrabajo.htmMunilla, F. et al. Dynamics of the Origin and Application of Funds in Liquidity Management. CONTHABANA International Event 2005. Havana, 2005. Van Horne, Wachowicz. Fundamentals of financial administration. 8th edition. Prentice Hall Hispanoamericana. 1997. Weston, F. and E. Brigham.Fundamentals of Financial Administration. McGraw Hill Publishing. 10th Edition. Spain, 1994. Weston, F and T. Copeland. Administration finance. McGraw Hill Publishing. 9th Edition. Mexico, 1995.
