Advanced Credit Risk Analysis and Management

12

Credit Risks in Working Capital

Working capital is known as the blood of business. No business can survive without adequate working capital. A business without sufficient working capital is like an anaemic person. An anaemic is a person lacking sufficient red blood cells, which makes them weak and unhealthy. All interested parties will be concerned about an anaemic person, and so will suppliers of credit if their customer displays symptoms of business anaemia – viz. lack of working capital impacting the creditworthiness of customers. Working capital credit risks will lead to liquidity problems, which in turn, could result in non-settlement of bank liabilities, suppliers and other creditors.

Let us examine the nature of working capital, as the first step to understanding the major credit risks involved. Working capital is the basic requirement of any business. It refers to that part of the capital required to purchase raw materials, pay for the salaries and wages of employees, meet the movement costs of goods and similar recurring expenses. It takes into account trade credit given to customers and that received from suppliers. The timing mismatch between the transfer of title to the product and settlement of dues along with routine expenses (salaries, freight expenses, etc.) give rises to the demand for short-term funds.

12.1 DEFINITION OF WORKING CAPITAL

Usual balance sheet definition of working capital is given below:

Current assets are those assets of the business which ...