Title: Components of Working Capital (Top 4) | Detailed Explained
Headings: Components of Working Capital
Components of Working Capital
What are the Components of Working Capital?
4 Main Components of Working Capital
#1 – Trade Receivables
#2 – Inventory
#3 – Cash and Bank Balances
#4 – Trade Payables
Conclusion
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Content: The importance of trade receivable is equally reinforced as most of the analysts while evaluating a business check receivables turnover ratio to understand the working capital management efficiency in collection of payments for credit sales undertaken by the business and also to derive bad debts incurred by the business. #2 – Inventory
Inventory is another significant part of current assets and, without a doubt, forms an integral component of working capital management. Good Inventory Management is essential since it is responsible for proper control over inventory right from the raw material stage to the finished goods stage. Inventory Management begins with inventory control and involves the timely purchase, proper storage, and efficient utilization to maintain even and orderly flow of finished goods to meet timely commitment by the business and at the same time avoid excess working capital in holding of inventory as that will result in a delay in cash conversion cycle and also increase the risk of obsolescence and increase working capital requirement which adversely impacts the profitability of the business. Inventory can be valued by business in different ways which are enumerated below: FIFO Inventory
Last in First Out Accounting
Weighted Average Method
The choice of any of the above three methods has an impact on the current assets reported by the business and, consequently, the working capital of the business as inventory. Some of the most popular inventory control techniques for effecting working capital management are as follows: Min Max Plan
The oldest and conventional method which revolves around determining the maximum and minimum of each stock item be kept following the usage, requirements, and margin of safety to ensure that the business doesn’t lose the risk of stock-out and also to avoid the issue of overstocking as it adversely impacts working capital. Order Cycling System
Under this Inventory Management system, quantities of each stock item are reviewed periodically, which is predetermined by the management based on the production cycle and order is placed based on stock level and probable rate of depletion before the next periodic review. ABC Analysis
Under ABC analysis technique of inventory management, the different stock items are ranked in order of their money value.