Wednesday, February 13, 2013

Dangers of Excessive and Deficiency of working capital

Working capital is just like a heart of business. If it is weak it cannot pump blood and human being cannot work and survive for long. Likewise if the working capital level of a firm goes down and higher investment in fixed asset will also effect in the business. Here dangers of deficiency and excessive working capital and advantages are discussed. Dangers of deficiency of working capital mean the low level of working capital than the required. This can be explained under. 
   Deficiency of working capital   may lead to business failure as the working capital is the heart, when it pumps slowly to the day to day operation. Business requires a clear operated environment everyday otherwise it leads to death.  The firm cannot take advantage of new opportunity or adopt change. Because inadequate financial troubles always become a headache for the managers, they cannot concentrate the untapped opportunities arising in the market.  Trade discount and    cash discount will be lost. Trade discount is the discount received at the time of purchasing raw materials. If we have adequate financial balance in our hand, we can meet the purchase amount and get the advantage of trade discount. Cash discount is the discount received after purchasing the raw material. There will be a credit period to repay the money. If we have enough cash, we can pay the money before the maturity date and get the discount.
  Financial reputation of the firm may be lost due to deficiency of working capital. A firm always complaining about shortage of money and losing the credit paying capacity leads to the loss of reputation. Creditors may apply to court for winding up. Creditors will be fed up with the search of their money repeatedly they definitely approach court to get the money back.  It also affects dividend policy adversely. Dividend policy is made on the profit earned by the organization. Inadequate working capital affects the profitability. This will reduce the rate of dividend. The company cannot utilize its fixed assets properly. A business firm may invest certain percentage of their capital in fixed asset. To run that fixed asset in full swing, there should be working capital. Machinery needs several financial requirements such as operators, electricity, fuel, oil etc.

Dangers of Excessive working capital mean the excess of the working capital above the normal. The dangers are discussed as; excessive working capital means idle funds in the business which gives no profit. Thus the rate of return falls. An idle fund doesn't make any result. It makes a burden to the organization. The value of share may fall due to lower rate of return on investment.  Efficiency of management may be declined. When there is sufficient fund in the business, accounts the management tends to lazier and the return remains the normal. But when we analyze the rate of return, it will be decreased. This affects the share price in the capital market.  Increased bad debt and wastage occurs. The management sometimes decide to raise the bad debt level and no efforts will be there to get the money back, when there is excess money in hand. This leads to low efficiency and wastage of money.

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