Balanced Working Capital Position
The firm should maintain a sound working capital position. It should have a adequate working capital to run its business operation. Both excessive as well inadequate working capital positions are dangerous from the firm’s point of view. Excessive working capital means holding costs and idle funds which earn no profits for the firm. Paucity of working capital not only impairs the firm’s profitability but also results in production interruptions and inefficiencies and disruptions.
The dangers of excessive working capital are as follows :
o It results in unnecessary accumulation of inventories. Thus chances of inventory mishandling, waste, theft and losses increase.
o It is an indication of defective credit policy and slack collection period, Consequently, higher incidence of bad debts results, which adversely affects profits.
o Excessive working capital makes management complacement which generates into managerial inefficiency.
o Tendencies of accumulating incentories tend to make speculative profits grow. This may tend to make dividend policy liberal and difficult to cope with in future when the firm is unable to make speculative profits.
In adequate working capital is also bad and has the following dangers :
- It stagnates growth. It becomes difficult for the firm to undertake profitable projects for non-availability of working capital funds.
- It becomes difficult to implement operating plans and achieve the firm’s capital funds.
- Operating inefficiencies creep in when it becomes difficult even to meet day-to-day commitments.
- Fixed assets are not efficiently utilized for the lack of working capital funds. Thus, the firm’s profitability would deteriorate.
- Paucity of working capital funds render the firm unable to avail attractive credit opportunities etc.
- The firm loses its reputation when it is not in a position to honour its short-term obligations. As a result, the firm faces tight credit terms.