Working Capital Policy and Liquidity in the Small Business

Introduction
Working capital management is one of the most critical elements in the operation of a small business. The two components of working capital are: Gross working capital: sum of current assets of a firm. Net working capital: Current assets-Current liabilities.

Importance of working capital

Small business are involved in retailing and whole selling, current assets play a major role. Small business have difficulty in obtaining long term financing due to which it should efficiently manage its working capital to manage the need for finance.

Objective
The main objective of this study is to describe the working capital policy and liquidity in small businesses.

Methodology
A descriptive research design has been used for this study since it involves theoretical concepts.

Concepts highlighted in the article

Working capital policy: Working capital policy is the set of principles and plans that establishes a course of action for dealing with current assets and current liabilities. There are two views on working capital policies: 1. On the basis of net working capital 2. On the basis of the amount of long term financing used.

On the basis of net working capital

A working capital policy can be: 1. Aggressive : high degree of short term financing to finance assets 2. Conservative : preference to hold more cash 3. Moderate : it balance between long and short term financing

Determinants of net working capital

1. Liquidity 2. Deferability of current liabilities

1. Liquidity
As we know liquidity is the ability of an asset to be converted into cash with minimal loss. The factors of working capital that affect liquidity are :

 Operational aspects of the firm: It includes utilization of inventory turnover ratio, credit sales, receivables collection period etc all of which are in the working capital policy. The marketing area of the policy influences the operational aspects of the firm. The amount of cash held by the firm is also mentioned, higher cash holding higher liquidity. Non-operational aspects of the firm: It refers liquidation value of current assets. It depends on the magnitude and degree of current assets and the ability to dispose them with minimal loss. Forecast future sales: The higher the ability to forecast sales, more liquid the current assets. However small firms have difficulty in forecasting, thus affecting cash levels.

2. Deferability of current liabilities

Deferring or postponing the accruals can also increase liquidity. However the postponability of accruals is difficult to accounting or legal nature. The average payment period, which is a mentioned in working capital policy can be increased or decreased. Notes payable is generally not postponable, it is renewable. The decision whether to renew or not depends on the lenders ability, economic factors and the current state of the firm.

Aggressive working capital policy

An aggressive policy is one that has: Above average profit margin Current assets high proportion of total assets High degree of short term financing Above average inventory turnover Rewards: Low inventory costs, due to fast moving inventory Lower collection cost due to aggressive credit and collection policy Lower financial cost due to short term financing Risks: Inability to meet short term obligations Short term financing may not be available during recession Average payment period extension is generally not accepted to suppliers

On the basis of the amount of long term financing used

This view emphasizes that the larger proportions of long term financing create higher levels of working capital. Also small business suffers from lack of long term financing. So net working capital is inadequate.

Summary and conclusion

It attempts to place working capital policy in perspective with other policies in small business. Working capital policy must be expressed in terms of liquidity, deferability of sales and consumption of financing. The working capital policy is of vital importance to a small business.