Managing Working Capital Model Risk

Working capital is the cash a company needs to keep its business running. This includes paying for raw materials, making salary payments, etc. To assess working capital model risk, , a company must examine carefully both its current assets and current liabilities.
Current assets include cash, cash equivalents, accounts receivable and inventory. Current assets represent money that is available to the company.
Current liabilities include accounts payable and short term debt. Current liabilities represent the organizational commitments that the company will have to meet in the near future, typically within one year.
The difference between current assets and current liabilities is nothing but the working capital. Capital has a price. So the better the company manages its working capital, the less external capital it will have to raise. If a business can manage with little working capital, it is a great situation to be in. A few key questions must drive working capital model risk, according to Mullins and Komisar (“Getting to Plan B”, Harvard Business Press, 2009).
§ How can customers be encouraged to pay quickly?
§ How much inventory must be maintained to run the business effectively?
By keeping working capital needs low or negative, a company can put itself in an enviable situation. On the other hand, heavy working capital needs add to the business risk.