I was reading some articles and found that working capital management is measured by net working capital cycle and also working capital efficiency is measured by the same measure. Can anyone shed light as to what is working capital management efficiency?
Efficient working capital management involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet due short term obligations on the one hand and avoid excessive investment in these assets on the other hand (Eljelly, 2004). Therefore, working capital management can be considered as a part of corporate finance due to the fact that it deals with current assets and current liabilities.
WC "efficiency" is roughly included in the Unlevered Free Cash flow computation as the Net WC spending (NWCsp) , the difference between last WC and current WC--i.e., as Mahfuz said, a penalty to (1) excessive investments in operating current assets (OCA=CA - cash) and (2) insufficient usage of operating current liabilities (OCL=CL-ST borrowing-current portion of ST debt and capital leases) to finance its OCA needs .
Digging further into WC spending, you will look at the cash conversion cycle (how long does it take to convert the $ sales into cash). For instance, if a retail company has excessive inventory build-up (growing faster than its revenues), it will take longer to convert its sales into cash and it will have increasing NWCsp over time (which decreases future UFCFs, the enterprise value, and ultimately the market cap). Theoretically, if you neglect time value, NWCsp should be equal to zero over time (if you liquidate the company, you will convert the inventory and receivables into cash, and pay off the payables). Now, going back to our retail company with excessive inventory build-up, if it eventually unloads it at a discount, it will produce ST "artificial" cash flows; but in the end, its NWCsp will increasingly consist of a use of cash, and the company's value will decrease over time.
I think in the for the efficient working capital, the components of current assets are also important. To be more specific the liquidity components of current assets. For example if an organization's major part of current assets is consisting of closing stock of raw material or unsold goods it cannot be realized in a short notice for meeting the working capital requirement of an organization. This will lead to financial crunch to meet short term obligations and ultimately lead to inefficient working capital management.
Simply, the optimum utilization of Cash Conversion Cycle (CCC), Average Collection Period (ACP), Average Payment Period (APP) and Inventory Turnover (IT) is called Working Capital management efficiency.
What do we mean by optimum utilisation of CCC,,,its not a resource where we can utilse it optimally, same goes for other measures like ACP,APPP,IT etc
Median figure of each component of WC in a specific Industry can be used as a proxy for optimum utilization
Working capitaNeeds (WC) are key element for competion. As such they are rigorously managed by firms. This fine tuning is particularly importanat in recession and macro economic downtrurn. The sensitivity of WC to external conditions are parameters of corporate efficiencey, particularly in the last financial crisis. See Aktas (2013)'s nice paper.
Efficient use of both current assets and current liabilities being the components of the working capital would lead to Efficient use of WC. CA includes cash, inventory and sundry debtors - each of these has to be utilised optimally, minimum idle cash holding, minimum inventory of raw materials, work in process and finished goods as well as the least time to recover outstanding debtors (created by credit sales). Likewise the current liability components - viz. sundry creditors and the current (bank or other short term borrowings) to be used to the hilt (sometimes even to the maximum time allowed) so that your payables are stretched while receivables are realised early. The efficiency of these would greatly depend on the short cash conversion cycle (time taken to convert cash to raw materials, to work in progress, then to finished goods, then both cash and credit sales, realising outstanding and then again buying raw materials and putting into the operating cycle once again. How easity and early you can complete the cycle shows the efficient use of WC.
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