Business runs on two
motives- 1. Short run, 2. Long run. For the short run, the firm aims to earn a
regular profit for day-to-day operation, while in long run, the firm focuses on
sustainability. So as per requirement, the firm decides what to manage - Working
Capital or Financial Debt. Both are two different sides of the balance sheet but
have their own significance and effect. Both represent a business in a
different way.
Adequate working capital
defines the solvency of a firm. Solvency means the ability to pay. On another
hand, a strong financial statement shows liquidity and its capital dependency.
This capital is classified into owners and debt. Debt means borrowing fund in
terms of loan or debentures or any securities which should be paid first before
shareholders. So, it is risky as well as beneficial in terms of cost of
capital. With this, securitization is one of the factors to differ both.
A firm should define the
problem and requirement. Because if a firm wants to maintain payables with
minimum securities in assets to the supplier, then it is advisable to manage
working capital; as working capital is part of assets but not securities
against any long-term liabilities. Financial debt is nothing but all those
items in the balance sheet which should be secured by valued assets. For this,
the valuation model and the cash flow statement are beneficial.
Average working capital
differ from month to month but in long run it is constant. While there is not
much fluctuation in long term debt as its valuation and redemptions are not
made within 1 year a line between working cap or debt depends upon type of
firm. Because securitisation of seasonal firm is short run.
For example, seasonal
businesses used capital as working capital and for financing assets. Reason is,
they invest and use this money for less than 1 year, and to show assets or
liabilities on the date at the end of the year include final record for more
than one business, hence respective working capital balance becomes asset of
the respective business for that firm.
So, to decide where to
draw line simply depends upon:
1. Type of business
2. Needs & Requirements
of the business
3. Securities
Thank You
Regards
Author- Tanvi Dange
Kautilya
IBS Mumbai
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