• Reduction of working capital is a method of financing a business by decreasing its current assets and/or increasing its current liabilities to generate cash flow.
  • It involves using the cash generated from reducing current assets or increasing current liabilities to meet short-term financial obligations.

Features of Reduction of Working Capital as a Source of Finance:

  • Involves reducing current assets or increasing current liabilities.
  • This can be in the form of:
    • Delaying payment to suppliers
    • Reducing inventory levels
    • Negotiating longer payment terms with customers
    • Tightening credit policies to reduce accounts receivable
    • Selling excess or obsolete assets
    • Streamlining operations to reduce costs
    • Outsourcing non-core activities to reduce expenses
    • Implementing lean manufacturing or just-in-time practices to reduce inventory and improve cash flow.
  • Provides short-term financing for the business.
  • May result in reduced liquidity for the business.
  • Can be a temporary solution to cash flow problems.
  • May have an impact on the company’s credit rating.
  • May require approval from creditors or investors.

Situations where Reduction of Working Capital may be Appropriate:

  • When a company needs to raise funds quickly.
  • When a company has excess inventory or accounts receivable.
  • When a company has short-term debt that needs to be paid off.
  • When a company has a seasonal business and needs to manage cash flow during slow periods.

Benefits of Reduction of Working Capital as a Source of Finance:

  • Can be a quick solution to cash flow problems.
  • May not require external financing or additional debt.
  • Can help to improve a company’s cash conversion cycle.
  • Can free up resources for other investments or activities.

Drawbacks of Reduction of Working Capital as a Source of Finance:

  • May result in reduced liquidity for the business.
  • May impact the company’s credit rating.
  • May only be a temporary solution to cash flow problems.
  • May require approval from creditors or investors.
  • May result in reduced current assets that are needed for day-to-day operations.
  • May not be a suitable option for companies that have already reduced working capital to a minimum.

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