Set of conflicts in reducing working capital

Question

Give an illustration of a set of conflicts encountered when attempting to reduce working capital?

Answer 1

If any enterprise wants to have an aggressive policy with regard to the level of investment in working capital it will have to face lot of conflicts. As we all know working capital is based on cash conversion cycle that is from purchasing raw materials to finally realizing cash from debtors. An aggressive policy will increase profitability since less cash will be blocked in current assets but the risk of cash shortage or stock-out increases.

In attempt to reduce working capital aggressively, can create tension between buyers and suppliers. While the management will want to hold cash for decent returns, the suppliers will like to get immediate payment for maintaining their cash flow. In such practice the benefit of cash discount by paying early is lost and terms with suppliers also spoils which can hamper a lot to the business in future. The importance of raw materials or trading goods cannot be exaggerated, so  is the bad relation or terms with the suppliers.

If any company maintains minimum level of inventory required in the business then there can be chance of stock out anytime a supplier delays in sending goods or if production process fails any day due to any of the various reasons management can lose its customers to its rivals. Moreover if any opportunity comes to deliver goods instantly for a extraordinary high price, the management can never be able to recover that loss if that benefit is availed by its peers.

In order to reduce working capital, if management reduces its credit policy below the industry standard it can anytime lose it customers to its rival giving a better credit facility.

It is advisable to maintain working capital in the same level as the other companies in the same industry are maintaining. Any level above or below the industry standard can be crucial for the company.