In addition to efficiency and liquidity of working capital, management should also look into its structural health aspects. The structural health of the working capital in the business is generally studied by analyzing the shifts and changes between its various elements i.e. cash receivables, inventories and other items of current assets.

Decomposition analysis can help management to detect the occurrences and changes in a firm’s resource allocation over a period of time. If after scanning the data any unusual phenomenon is detected, management can further investigate that in depth. Under decomposition analysis, the value of individual items can be seen in relation to total value of the current assets in relation to total assets. Likewise, the proportion of short-term liabilities can be gauged with respect to total liabilities. The following ratios are generally used to analyze the structure of working capital in the business and have been found to be quite useful:

  1. Current assets to total assets ratio.
  2. Cash to current assets ratio.
  3. Receivables to current assets ratio.
  4. Inventory to current assets ratio.
  5. Current liabilities to total liabilities ratio.

All these ratios are very simple to calculate and if analyzed together they indicate area of strength and weakness in the sphere of working capital management.

These ratios can be studied over time and/or compared with an industrial average to find out useful dues to be investigated further for any corrective action.

Remember: This set of ratio helps to evaluate structural shifts and changes that have taken place over time and are indicators of structural health of working capital.

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Working Capital Management Topics