Working Capital Management^167
Characteristically, current assets represent more than half the total as-sets of a business
firm. Because they represent a large investment and because this investment tends to
be relatively volatile, current assets are worthy of the financial managerís careful
attention.
Working capital management is particularly important for small firms. A small firm may
minimize its investment in fixed assets by renting or leasing plant and equipment, but
there is no way it can avoid an investment in cash, receivables, and inventories.í
Therefore, current assets are particularly significant for the financial manager of a
small firm. Further, because a small firm has relatively limited access to the long ñ term
capital markets, it must necessarily rely heavily on trade credit by increasing current
liabilities.
Relationship between Sales, Growth and current Assets
The relationship between sales growth and the need to finance current assets is close
and direct. For example, if the firmís average collection period is 40 days and if its
credit sales are 1,000 a day it will have an investment of 40,000 in accounts receivable.
If sales rise to 2,000 a dayí the investment in accounts receivable will rise to 80,000.
Sales increases produce similar immediate needs for additional inventories and,
perhaps, for cash balances. All such needs must be financed, and since they arise so
quickly, it is imperative that the financial manager keep himself aware of developments
in the working capital segment of the firm. of course, continued sales increases will
require additional long- term assets, while must also be financed. However, fixed asset-
investments, while critically important to the firm in a strategic, long ñrun sense do not
generally have the same urgency as do current asset investment
Original Concept of Working Capital
The term ì working capital íí originated at a time when most industries were closely
related to agriculture. Processors would buy crops in the fall, process them, sell the
finished product, and end up just before the next harvest with relatively low inventories.
Bank loans with maximum maturities of one year were used to finance both the
purchase and the processing costs, and these loans were retired with the proceeds
from the sale of the finished products.
The situation is depicted in Figure 1. There fixed assets are shown to be growing
steadily over time, While current assets jumps at harvest season, then decline during
the year, ending atzero just before the next crop
is harvested. Short-term credit is used to finance current assets, and fixed assets are
financed with long-term funds. Thus the top segment of the graph deals with working
capital.