Investment in Working Capital Concept
The need of investment in Working Capital is directly related with the fact that the company has need to invest in stocks of merchandise and used materials in the productive process and still for the fact of giving and receiving credit of clients. Beyond the stock applications and in clients’ credit, the company also has the need to maintain a certain amount of cash as a way to guarantee some safety in the payments that needs to make on a daily basis. To refer that, these needs are deducted to the given credit by merchandise, materials or services suppliers.
Therefore, the working capital needs are greater when:
- Greater the desired cash security to guarantee the activity’s normal payments; for example, if, on its constitution, the company desires to have in Cash a sufficient amount to cope with the activity’s first month expenses, the cash investment will be equivalent to the addition of the foreseen expenses that month.
- Greater the average receipt deadline given to the clients; for example, if, on its constitution the company decides to sell its products on a 60 day credit, the company needs to invest in merchandise the equivalent to the first 60 days of activity.
- Greater the average warehouse stock deadline; for example, if, on its constitution the company intends to keep in the warehouse a stock enough for 30 days of activity, needs therefore to invest in stock the equivalent to the sales of the first 30 days of activity.
- Smaller the average suppliers’ payment deadline; for example, if, the company on its constitution agrees with its suppliers an average payments deadline of 60 days, then the initial investment becomes smaller on the equivalent of 60 days of purchases.
The working capital needs correspond, so, to the sum of cash minimum availabilities with the credit given to clients and with the amount of stocks in the warehouse subtracted from the credit given by merchandise suppliers.
On the company’s constitution the working capital need is equivalent to the necessary investment in working capital; for companies already formed, the working capital investment corresponds to the variation of working capital needs.
Usually, and for companies already formed the self-financing generated by the activity is enough to finance the working capital investment needs except when there are big increases in the activity and/or the company presents low profitability rates.
