Investment in Working Capital:
It means to invest money in liquid and current assets. We all recognize that working capital is significant, when we want to operate our fixed assets more proficiently. Similar to investment in fixed capital decision, investment in working capital decision is as well significant. In working capital investment, we keep our money in cash. We as well invest our some money in the form of debtors, inventory and short term securities. Value of this investment should be more than our current liabilities.
Now the important question is that, "How much additional amount must be invested?" Current assets are $ 10000 and our current liabilities are $ 7000. Our investment in working capital is $ 3000. Now, question is, whether $ 3000 investment is adequate or not.
To know this answer, we have to study numerous factors that affect our investment in working capital.
Note: We are studying such factors since we are interested to optimum investment in working capital. When we invested money in working capital, it will not make gain and our gain will reduce. When we invested money in working capital, it will raise the risk of our solvency. Assume that we have no money to pay our creditor on the time due to below working capital investment. This means, he has to defy our solvency.
A. Inventory Cycle:
We require investment of working capital for purchasing raw material. We have to compute inventory conversion period. This will tell us when our inventory cycle will complete. According to this, we consider to invest our money in the working capital.B. Creditor Conversion Period:
We have to save little money for paying our creditors. Both long and short term creditor’s payment is from cash. Our creditor conversion period will elucidate when we have to pay them subsequently.C. Debtor Conversion Period:
We too expect that our debtor will provide our money after some time however when they will provide our money. Up to that time, we require investing money in debtors, after finishing debtor conversion period; we require not investing money in debtors. Assume that, our debtor will pay after 60 days. This means only for 60 days, we require money to buy goods and paying other expenditures. Although after 60 days, we will get money from debtors, this means no necessitate investing extra amount in cash as same cash we will acquire from debtors.D. Unexpected Expenses:
Some expenditure, we do not suppose due to uncertainty. Assume that our employee is doing our company's duty and in the market, if he faces accident and he encompasses no money for treatment, it is the responsibility of company to pay his treatment bill. However company is not NGO that will help. But taking it as social accountability, company can pay in the form of loan to member of staff. However for this, company has to take decision to invest his working capital for those unpredicted expenses.E. Our Approaches:
A few companies invest in working capital on approaches basis. For illustration, according to matching approach, company will invest long term finance in the long term fixed assets and short term finance in short term current assets. However its opposite is conservative approach in which company invest his long term finances in the long term fixed assets and as well in short term current assets.
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