Working Capital Management^183
As the level of working capital increases, shortage costs go down while the carrying
costs increase. This means that there would be a point where the sum total of carrying
costs and the shortage costs would be the lowest. This is the optimum level of current
assets that the company should keep.
In addition to the working parameters peculiar to a company that determine the quantum
of required working capital, the following factors are also equally important:
- Profit levels: A company earning huge amounts of profits can add to the working
capital pool a larger quantum of funds. Such companies should, however, guard
against the temptation of expanding beyond necessity and tying up the funds in
unproductive capital expenditure or allow unnecessary increase in overheads.
Generally it is seen that companies with high profit levels become lax in
management of funds and usually mismanage by blocking funds excessively in
stocks or debtors. - Tax Levels and Planning: Income Tax laws provide for payment of advanced
tax in instalments. Excise and sales tax are payable at time of despatch of goods
from the factory premises and the point of sales respectively. Any working capital
management must make adequate and timely provision for the same as all of
them involve cash outlays. - Dividend Policies and Retained Earnings: Dividend policy and retained
earnings are directly related. There has to be a proper balance between the need
to preserve cash resources and the obligation to satisfy shareholder expectations.
Sometimes reserves are sacrificed for consistent dividends. Dividends once
declared become a short time liability which has to be paid for in cash and this
impact should be recognised in the working capital budget. On the other hand, it
would be of little satisfaction to the general body of the shareholders to enjoy a
liberal dividend at the expense of ploughing back the same for the growth of the
company. Reserves in the form of retained earnings is a very important source of
augmenting working capital. - Depreciation Policy: The extent to which depreciation provision is made during
the course of making the financial statements has a direct bearing on the dividend
policy and retained earnings. This so because a higher quantum of depreciation
would leave lesser profits resulting in reduced retained earnings and dividends.
The quantum of depreciation can be made to vary by choosing different methods
to provide for the use of assets. As provisions for depreciation are actually only
book entries and represent no cash flow at that time, they will have no bearing on
working capital except to the extent they may hold back distribution of dividends. - Expansion/Diversification Plans: Addition of fixed assets to produce new