The basic objective of financial management is to maximize shareholders wealth. This is possible only when the company earns sufficient profit. The amount of such profit largely depends upon the magnitude of sales. However, sales do not convert into cash instantaneously.
There is always time gap between the sale of goods and receipt of cash.Working capital is required for this period in order to sustain the sales activity. This refers to that minimum amount of investment in all current assets which is required at all times to carry out minimum level of business activities. It represents the current assets required on a continuing basis over the entire year.
Tandon committee has referred to this type of working capital as “core current assets”.
The following are the characteristics of this type of working capital:-
- Amount of permanent working capital remains in the business in one form or another. This is particularly important from the point of view of financing. The suppliers of such working capital should not expect its return during the lifetime of the firm.
- It also grows with the size of the business.
Permanent working capital is permanently needed for the business and therefore it should be financed out of long-term funds.
This is the reason why the current ratio has to be substantially more than ‘1’. The amount of such working capital keeps on fluctuating from time to time on the basis of business activities. In other words, it represents additional current assets required at different times during the operating year.
A firm must have adequate working capital, i.e., as much as needed by the firm. It should neither have excessive nor inadequate. Both situations are dangerous. Excessive working capital means the firm has idle funds, which earn no profit for the firm. Inadequate working capital means the firm does not have sufficient funds for running its operations, which ultimately results in production interruptions, and lowering down the profitability.