Working capital refers to a firm's investment in short term assets, viz. Cash, short-term securities, inventories, accounts receivables, etc. Improved profitability of a firm, to a great extent, depends on its efficiency in managing working capital. Some of the parameters for judging the efficiency in managing working capital are:

• Whether there is enough assurance for the creditors about the ability of the company to meet its short-term commitments on time. Hence, a reliable index is whether a company can settle the bills on due dates. The finance department has to plan in advance to maintain sufficient liquidity to meet maturing liabilities.
• Whether maximum possible inventory turnover is achieved. The adverse effect of ineffective inventory management may not be offset even by the most efficient management of other components of working capital.
• Whether reasonable credit is extended to customers. This powerful instrument to promote sales should not be misused. The other side of the same coin is receiving credit. Both depend upon a company's strength as a seller and as a buyer.
• Whether adequate credit is obtained from suppliers. It depends upon the company's position in relation to its suppliers and the nature of supply market, i.e., whether there is a single supplier or a large number of suppliers. With coordination of efforts buyers can be in a position to negotiate competitive credit terms even if there is a single supplier and his ability to control the market. At times the supplier imposes the credit terms as 100% advance, i.e., negative trade credit.
• Whether there are adequate safeguards to ensure that neither overtrading nor undertrading takes place.

The following indices can be used for measuring the efficiency in managing working capital:

Current Ratio (CR)

CR = Current Assets/Current Liabilities
It indicates the ability of a company to manage the current affairs of business. It is useful to study the trend of working capital over a period of time.

Quick Ratio (QR)

QR = Liquid Assets/Current Liabilities
Where liquid assets include Cash in hand, Cash at Bank, Sundry Debtors, Bills Receivable, Short-term Investments etc. In other words, all current assets are liquid assets except stock and prepaid expenses.

Current liabilities include Sundry Creditors, Bills Payable, Bank Overdraft, Outstanding Expenses etc.

Cash to Current Assets: If cash alone is a major item of current assets then it may be a good indicator of the profitability of the organization as cash by itself does not earn any profit, the proportion should usually be kept low.

Sales to Cash Ratio

Sales to Cash Ratio = Sales/Average cash balance during the period.
Cash should be turned over as many times as possible, in order to achieve maximum sales with minimum cash on hand.

Average Collection Period

(Debtors/Credit Sales) x 365
This ratio explains how many days of credit a company is allowing to its customers to settle their bills.

Average Payment Period

Average payment period = (Creditors/Credit purchases) x 365
It indicates how many days of credit is being enjoyed by the company from its suppliers.

Inventory Turnover Ratio (ITR)

ITR = Sales/Average Inventory
It shows how many times inventory has turned over to achieve the sales. Inventory should be maintained at a level which balances production facilities and sales needs.

Working Capital to Sales: It signifies that for any amount of sales a relative amount of working capital is needed. If any increase in sales is contemplated it has to be seen that working capital is adequate. Therefore, this ratio helps management in maintaining working capital, which is adequate for the planned growth in sales.

Working Capital to Net Worth

Working Capital/Net worth
This ratio shows the relationship between working capital and the funds belonging to the owners. If this ratio is not carefully watched, it may lead to overtrading & undertrading. Efficient working capital management should, therefore, avoid both overtrading and undertrading.