Ganesan (2007, p.1) defined working capital management as a company’s best strategy for its continued sustainability since it uses short-term financing strategies to fund everyday operations (Ajibolade and Sankay, 2013, p.233). The pecking order theory believes that internal financing is the best alternative but it can result to conflicts between corporate liquidity and profitability (Ajibolade and Sankay, 2013, p.234). The reason for this is that the company’s internal funding may not be enough to fund the period between the purchase of inventories or raw materials until the collection of receivables (Gill, Biger, and Mathur, 2010, p.1).
Having a positive or negative working capital value is primarily due to the decision of the company with regards to terms given to customers, inventory levels, and terms given by the creditors (Gill, Biger, and Mathur, 2010, p.1). The combination of these three decisions can result in a longer time lag, which will require higher working capital requirements (Gill, Biger, and Mathur, 2010, p.1). In order to minimize deficiency in operational funding, the company may use 4 working capital sources, which are bank loans, lines of credit, factoring, and trade credits (Nelson, 2014).
Between the four sources, Ganesan (2007, p.10) suggests that trade credits from creditors are the best option since it gives the company enough time to collected receivables and reduce inventory levels. This can be done through verbal or written agreements with trade creditors by delaying payment terms (Nelson, 2014). However, this short-term funding is considered to be appropriate for companies with inefficient inventory management (Ganesan, 2007, p.10). Most companies will not be able to match the value of current assets with current liabilities due to differences in working capital management decisions (Gill, Biger, and Mathur, 2010, p.2).
Even through most companies prefer to have a positive working capital value (Gill, Biger, and Mathur, 2010, p.2) there are some cases where companies can generate a negative working capital (Hoffelder, 2012). The use of a negative working capital value is that it can infer financial distress but can be also considered as having a better managerial efficiency (Panigrahi, 2014). This is especially true in the communications sector wherein the companies require payments in advance before services are rendered resulting in higher current liability values (Hoffelder, 2012). Panigrahi (2014) revealed that the negative working capital resulted in improved managerial efficiency such as the case of DigitalGlobe. Companies with a higher positive working capital value can incur difficulties with regards to raising cash especially since idle funds do not generate profits (Panigrahi, 2014).
References
Ajibolade, S. O., and Sankay, O. C. (2013). Working capital management and financing decision: Synergetic effect on corporate profitability. International Journal of Management, Economics and Social Sciences, 2(4), 233-251.
Ganesan, V. (2007). An analysis of working capital management efficiency in telecommunication equipment industry. Rivier Academic Journal, 3(2), 1-10.
Gill, A., Biger, N., and Mathur, N. (2010). The relationship between working capital management and profitability: Evidence from the United States. Business and Economics Journal, 1-9.
Hoffelder, K. (2012). The positives of negative working capital. CFO. Retrieved from http://ww2.cfo.com/cash-flow/2012/06/the-positives-of-negative-working-capital/
Nelson, A. (2014). 4 Sources of working capital. Business Finance. Retrieved from http://www.businessfinance.com/articles/4-sources-of-working-capital.htm
Panigrahi, A. K. (2014). Impact of negative working capital n liquidity and profitability: A case study of ACC limited. International Conference of Prestige Institute of Management and Research, Indore. Retrieved from SSRN: http://ssrn.com/abstract=2398413 orhttp://dx.doi.org/10.2139/ssrn.2398413
