When talking about Rental Property Investments, the term ‘working capital’ has to be understood. There are two concepts of working capital: gross working capital and net working capital. Gross working capital is the total of all current assets. Net working capital is the difference between current assets and current liabilities.
It may be mentioned here that though this concept of working capital is commonly used, it is an accounting concept with little economic meaning. It makes little sense to say that a firm manages its net working capital. What a firm really does is to take decisions with respect to various current assets and current liabilities.
The management of working capital refers to the management of current assets as well as current liabilities. The major thrust, of course, is on the management of current assets. This is understandable because current liabilities arise in the context of current assets. Working capital is a significant facet of rental property investments because investment in current assets represents a substantial portion of total investment. Moreover, investment in current assets and the level of current liabilities have to be geared quickly to changes in sales. To be sure, fixed asset investment and long-term financing are also responsive to variation in sales. However, this relationship is not as close and direct as it is in the case of working capital components.
The importance of working capital management is reflected in the fact that financial managers spend a great deal of time in managing current assets and current liabilities. Arranging short-term financing, negotiating favorable credit terms, controlling the movement of cash, administering accounts receivable and monitoring the investment in inventories consume a great deal of time for financial managers.
In the management of working capital two characteristics of current assets must be borne in mind. Firstly, short life span and secondly, swift transformation into other asset forms. Current assets have a short life span. The life span of current assets depends upon the time required in the activities of procurement, production, sales and the degree of synchronization among them.
By John Benson