A Further Look at Working Capital Optimization in Medium-Sized Firms: Concepts and Evidence

A Further Look at Working Capital Optimization in Medium-Sized Firms: Concepts and Evidence

Milan B. Vemić (Higher School of Academic Studies “DOSITEJ”, Serbia)
Copyright: © 2017 |Pages: 34
DOI: 10.4018/978-1-5225-1949-2.ch008
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Abstract

SMEs battling with financial volatility require financial and business ambidexterity. To them working capital optimization is one partial solution to improve performance. Examined concepts will not develop a spectacular model but rather quantitatively - qualitatively upgrade existing theories. The treatise will demonstrate that in stochastic working capital decisions important are varieties of alternatives. A structural model of working capital optimization is developed with practical examples for financial decision making under uncertainty. Emphasis will be placed on structuring management problems with the analysis of preferences using probability tools. Additional light is shed on coupling static and dynamic indicators, systemically approaching inventory and cash management, sales and purchasing, costs and profitability. Working capital optimization can contribute to management of financial risk and have an overall impact in medium sized enterprises. Conclusions and recommendations will aim to contribute to the overall body of knowledge on optimized financial decision making.
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Introduction

The Small and Medium-sized Enterprise (SME) finance theory is the result of long and fruitful efforts of economists to account correctly for an extremely wide range of research results, which previously existing theory of the firm could not sufficiently explain. It is not generally acknowledged, however, that new approaches in SME and entrepreneurship financing represent a radical change, not only in the content of scientific knowledge, but also in the fundamental theoretical framework on the basis of which such knowledge can be applied in business. The true extent of this development of theoretical framework has possibly been clouded by the contrast between the relatively descriptive and smoothly understood definitions in which the neo-classical and even modern theories of the firm have regularly been expressed, with the quite abstract and mathematical inference in which this chapter formulates working capital optimization in medium enterprises. So sharp is this divergence that a significant number of economists were led to assume that working capital optimization entails relinquishment of classical financial management tools, and that instead, there should prevail rigorous mathematical optimization which can, in some enigmatic way, forecast precisely SME financial performance. However, further development of working capital optimization provides significant advantages. (See Vemic, 2015, for an exploratory case study.) These are fundamentally different attributes from those appearing in the theories of the firm. To produce such a conception of the working capital optimization theory in medium enterprises at a relatively practical level, in correspondence with static and dynamic ratios of financial analysis, is the main objective of this chapter.

The exact essence of the new working capital optimization concepts will be developed through the whole chapter, particularly in the section on the development of the structural model. First, the origin of the working capital optimization theory in medium enterprises is approached through static and dynamic indicators modified with author’s Toolbox for evolution of working capital management optimal functionality of structure. Second, the challenges are addressed through key factors of static and dynamic working capital optimization. The third main section involves the development of the structural model of working capital optimization in medium enterprises with a mathematical notation and with practical applications.

In correspondence with the prevailing plan outlined above significant emphasis is placed on showing how working capital optimization concepts can be applied practically without abandoning the classic static and dynamic financial analysis. It has been the author’s objective throughout this chapter to portray the main concepts of the working capital optimization theory in medium enterprises using both mathematical and non-mathematical inference in expectation that the reader will thereby perform more contemplation and undertake further exploration in this appealing area of scientific research.

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