Introduction
Business performance is measured by numerous financial metrics that help understand its different aspects. These metrics can be utilized to track company operations, improve its overall efficiency, and devise short-term and long-term strategies. One such metric is net working capital, which helps understand company liquidity. This paper will consider net working capital as well as the advantages of highly liquid firms against highly leveraged ventures.
Discussion
Net working capital is a crucial financial measure in the field of business. It accounts for the aggregate amount of the company’s current assets and current liabilities and shows its short-term liquidity (Keown et al., 2014). Current assets comprise cash, accounts receivable, inventories, marketable securities, and other resources that could be liquidated quickly (Keown et al., 2014). Meanwhile, current liabilities are debts the company can settle within a year (Keown et al., 2014). Therefore, the determinants of the net working capital of a venture are all items that directly contribute to the current assets and liabilities. The nature of the business and organization size, business cycle, production flow, seasonality, credit policy, growth rate, and payment terms can be viewed as determining factors of working capital (“The determinants of working capital,” 2022). Understanding net working capital determinants allows companies to employ the hedging principle and finance short-term expenditures with short-term gains (Keown et al., 2014). Thus, the established determinants are to be considered to define the suitable size of net working capital for a company, appropriately invest in current assets, and utilize current liabilities.
Furthermore, the cash conversion cycle is a critical measure that should be considered in building the net working capital. It can be broadly defined as the length of time required by the venture to convert the expenditures on inventory into cash through sales (Keown et al., 2014). The cash conversion cycle directly relates to the net working capital as its acceleration or deceleration impacts the current assets. Overall, net working capital determines the amount of cash available to meet expenses, while the cash conversion cycle defines how quickly cash spent returns to current assets.
Saudi Arabian companies can implement the hedging principle and cash conversion cycle controls to secure their market position and increase liquidity and profitability. According to Rahman Shaik (2021), business performance in the country is associated with financing terms of the suppliers and inventory costs. Profitability can be increased by accelerating the cash conversion cycle and utilizing the hedging principle by financing short-term obligations with short-term assets.
Although a variety of lines of credit, both unsecured and secured, are available to businesses and are often utilized, working capital remains an important measure. Net working capital illustrates how efficiently a company is functioning and is associated with profitability (Rahman Shaik, 2021)., Though business expenditures can be covered through credit and leverage, high liquidity better protects ventures against unexpected costs. It should be noted that highly leveraged companies tend to become somewhat liquid due to assets used as the funding source, returning profits that could be used to finance day-to-day operations. Nevertheless, highly liquid organizations have numerous advantages over highly leveraged ones due to their growth potential not being limited by debt and assets not being at risk of repossession. Furthermore, companies with fewer debt obligations are in a better position to increase debt if needed, as well as attract equity.
Conclusion
In summary, net working capital remains one of the most critical metrics in business. It allows for determining company liquidity by subtracting current liabilities from current assets such as cash, marketable securities, inventories, and accounts receivable. Net working capital can be increased or decreased via several strategies, including the hedging principle and cash conversion cycle. Overall, highly liquid companies have various advantages over those lacking liquid assets.
References
Keown, A. J., Martin, J. D., & Petty, J. W. (2014). Foundations of finance: The logic and practice of financial management (8th ed.). Pearson Education.
Rahman Shaik, A. (2021). Components of working capital and profitability in Saudi Arabian companies. Investment Management and Financial Innovations, 18(3), 52–62. Web.
The determinants of working capital. (2022). Accounting Tools. Web.