What are the reasons for not wanting to hold too little working capital? For not wanting to hold too much?

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What are the reasons for not wanting to hold too little working capital? For not wanting to hold too much?

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What are the reasons for not wanting to hold too little working capital? For not wanting to hold too much?

Explanation & AnswerSolution by a verified expert

Explanation

Working capital refers to the funds required by the company to meet its day-to-day operations. It is computed by subtracting current liabilities from current assets.
 
Purpose for not holding too little working capital-

A company holding inadequate working capital shall not be able to pay off its short-term liabilities and; hence, shall not be able to get better credit facilities.
Due to the unavailability of adequate funds, it becomes difficult to utilize fixed assets efficiently.
Due to a shortage of working capital, the company will not be able to achieve its objective. As a result, the average rate of return cannot be earned by the company.

 
Purpose for not holding too much working capital-

Excessive working capital leads to an accumulation of inventories or unnecessary purchases which increases the chances of wastage and losses.
When the working capital is more than needed, it increases the chances of negligence, resulting in a decrease in the efficiency of the company.
The excessive working capital is harmful to the company because the unused funds will bring in no revenue to the company. Hence, it will result in a downfall of the share price of the company.

Verified Answer

Purpose for not holding too little working capital:

It affects the debt paying ability of the company.
It decreases the efficiency of fixed assets.
It lowers the rate of return on investments.

Purpose for not holding too much working capital:

It increases the chances of losses and wastage.
It decreases the efficiency of the company.
It decreases the share price of the company.

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