On accounting approach to management of working capital
The accounting approach to management of working capital is regarded as fundamentally flawed basis for decision making as basis for decision-making regarding the optimization of investment in working capital because of the limitations associated with preparation of accounts related to the computation of cost of capital. Computing working capital makes use of the traditional concepts accrual accounting instead of the cash accounting. As there is the disregard of time value of money as commonly understood in finance, in accounting approach, the accrual accounting therefore causes the recording of accounts even if there is no actual cash involved. In particular, under the accounting approach, it would be a fundamental error to assume that liquidity in terms of a more that 1.0 current ratio or excessive working capital position of the company is necessarily optimal. In fact excessive working capital may actually be equivalent to inability to invest funds at cost of capital or higher. On the other hand, a company may have a low working capital at a certain point -- as usually the case because accrual accounting causes the preparation of balance sheet periodically -- yet it can meet its obligation before they are due because cash flows allows the same.