Literature Review
The importance of Working Capital Finance
The term working capital has several meanings in
business and economic development finance. In accounting and financial
statement analysis, working capital is defined as the firm’s short-term or
current assets and current liabilities. Net working capital represents the
excess of current assets over current liabilities and is an indicator of the
firm’s ability to meet its short term financial obligations.
Most fundamentally, working capital investment is the
lifeblood of a company. Without it, a firm cannot stay in business. Thus, the first,
and most critical, use of working capital is providing the ongoing investment
in short-term assets that a company needs to operate. A business requires a
minimum cash balance to meet basic day-to-day expenses and to provide a reserve
for unexpected costs. It also needs working capital for prepaid business costs,
such as licenses, insurance policies, or security deposits. Furthermore, all
businesses invest in some amount of inventory, from a law firm’s stock of
office supplies to the large inventories needed by retail and wholesale
enterprises. Without some amount of working capital finance, businesses could
not open and operate. A second purpose of working capital is addressing
seasonal or cyclical financing needs. Here, working capital finance supports
the buildup of short-term assets needed to generate revenue, but which come
before the receipt of cash. For example, a toy manufacturer must produce and
ship its products for the holiday shopping season several months before it
receives cash payment from stores. Since most businesses do not receive
prepayment for goods and services, they need to finance these purchase,
production, sales, and collection costs prior to receiving payment from
customers.
