Working capital management ensures that a business has an optimum amount of working capital. Working capital management involves a trade-off between two conflicting objectives liquidity and profitability. When a business holds too much working capital, it is said to be overcapitalized. An overcapitalized business has high levels of cash, inventory, and receivables, and low levels of payables (Talekar, 2005).
The benefit of having high levels of working capital is that such a business has adequate current assets to meet current obligations as they fall due. This means that such a business has a low risk of being illiquid. However, the high investment in working capital means increased financing costs that erode profitability (Talekar, 2005).
A business having low levels of working capital is said to be undercapitalized or overtrading. Overtrading refers to a scenario where a business attempts to support a large volume of trade using limited working capital. An overtrading business has low levels of inventory, cash, and receivables, and high levels of payables (Talekar, 2005).
The benefit of having low levels of working capital is increased profitability. However, low levels of working capital increase the risk of illiquidity. Therefore, businesses must avoid either extreme. Having too much working capital will lower its profitability, and having too low working capital will increase the risk of illiquidity.
TFC can improve its cash position by a faster collection of cash, negotiating with suppliers for longer credit terms, or reinvesting the dividends. TFC can improve the cash collection by offering cash discounts to the Body Builders to encourage them to settle their accounts faster.
However, TFC has to ensure that the benefit of receiving the cash faster outweighs the cost of the discount. Renegotiating the payments terms from $8,000 to $4,000 would improve the cash flow position. Reinvesting the dividends will result in an ending cash balance of $16,500. However, this option may cause dissatisfaction among shareholders and increase agency costs. TFC should only reinvest dividends as a last resort.