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Project report on working capital management in manufacturing sector

The management of working capital is completely different from industry to industry. Simple comparison of service industry and manufacturing industry can clarify the point.

In a service industry, there is no inventory and therefore one big component of working capital is already avoided. So, the nature of industry is a factor to determining the working capital requirement.

Working capital management is a very important component of corporate finance because it directly affects the liquidity and profitability of the company. It deals with current assets and current liabilities.

Working capital management is important due to many reasons. For one thing, the current assets of a typical manufacturing firm accounts for over half of its total assets.

For a distribution company, they account for even more. However firms with too few current assets may incur shortages and difficulties in maintaining smooth operations Horne and Wachowicz, 2000. Efficient working capital management involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet due short term obligations on the one hand and avoid excessive investment in these assets on the other hand Eljelly, 2004.

Working Capital Requirement - Manufacturing vs Service Sector- Differences

Firms may have an optimal level of working capital that maximizes their value. Large inventory and a generous trade credit policy may lead to high sales. Larger inventory reduces the risk of a stock-out. Trade credit may stimulate sales because it allows customers to assess product quality before paying Long, Maltiz and Ravid, 1993, and Deloof and Jegers, 1996. Another component of working capital is accounts payable.

Delaying payments to suppliers allows a firm to assess the quality of bought products, and can be an inexpensive and flexible source of financing for the firm. On the other hand, late payment of invoices can be very costly if the firm is offered a discount for early payment.

Why working capital management matters

The longer this time lag, the larger the investment in working capital Deloof 2003. A longer cash conversion cycle might increase profitability because it leads to higher sales.

  • Managing working capital means managing inventories, cash, accounts payable and accounts receivable;
  • This is due to several factors, including differences in collection and payment policies, the timing of asset purchases, the likelihood of a company writing off some of its past-due accounts receivable , and in some instances, capital-raising efforts a company is undertaking;
  • Efficient working capital management involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet due short term obligations on the one hand and avoid excessive investment in these assets on the other hand Eljelly, 2004.

This discussion of the importance of working capital management, its different components and its effects on profitability leads us to the problem statement which we will be analyzing.

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