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Any business owner or business manager that seeks growth in business operation must give high attention to Working Capital and must understand the relationship between Cash and Profits, to avoid running out of liquidity, to avoid excessive liquidity, and to be able to honor short-term financial obligations.

Firstly, let us explore the literally meaning of Working Capital, Cash and Profits, before exploring how to strike a balance on the three concepts in other to achieve effectiveness and efficiency in daily business operations. Working Capital is the cash needed for the day to day operation of business it is simply stated as the difference between Current Assets and Current Liabilities. Cash is the amount of money at hand and that which is in the bank account(s), and may also include highly liquid short-term investments owned by the business concerned.


Profits is simply the excess of revenue over expenses for any given measurement period. The common belief that profit has a positive co-relationship with the amount of cash available to a business entity is not absolutely true. This misconception may be attributed to the lack of understanding of what actually constitute a profit, may be they are not aware or had forgotten that revenue is made-up of both cash and credit sales, and that other incidental income includes both the earned and unearned income, and that the cost of sales and other expenses includes both the paid and the unpaid, and therefore, the ultimate cash that will be available to the business entity would depend on the amount of cash sales and the length of time it takes debtors to settle their obligations, against the amount of cash expenses and the length of time required for the business entity to settle all its financial obligations. From the above, it is clear that the management of working capital does not involve the management of cash only, but also, the management of other components of Working Capital, which are, the Inventories, the Account Receivables and the Account Payables.

Inventory, Account Receivable Cash and Account Payable Management

The knowledge of Inventory, Account Receivable Cash and Account Payable Management and their practical application in businesses operation is the prerequisites for maintaining a healthy and safe working capital position. There must be a guided procedure for determining the level of Inventories to be held, taking into considerations, there conversion and renewal periods, to avoid stock out and tying down of cash assets, these can be achieved by using the Economic Order Quantity Models, the ABC model and the Just in Time Purchasing Model. The management of Account Receivables involves checking the credit worthiness of potential debtors, deciding credit periods and terms. Managing Account Payable includes understanding of the payment periods and terms. While the Baumol and Miller Orr Model is very useful for Cash Management.

Lastly, no business owner or manager should forget to use Working Capital Ratios frequently to monitor it liquidity position, and gain the assurance of daily solvency.

Naghabun, Osayande.

About the Author

Naghabum Osayande is Accountant and loves to shares his thoughts on finance matters.

His specialities include audits, investigations, accounting advisory and business development

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