- Working capital is vital to the day-to-day operation of a business
- A lack of working capital often leads to business failure if the business cannot meet its immediate financial obligations
- Cash is the most liquid of a business's current assets and can be used to settle debts immediately
- Stock takes time to be sold and converted to cash to pay debts so is the least liquid current asset
- Effective management of working capital involves careful cash management
- If the finance manager is able to balance the flow of money in and out of the business, then the business is more likely to grow and be successful
- A business can hold too little or too much cash, both of which cause different issues
The Problems of a Shortage or Excess of Working Capital
Shortage of Working Capital
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Excess of Working Capital
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- Businesses may look to convert debtors and stock into cash as quickly as possible. This may mean they have to sell stock at low prices, reducing revenue
- Suppliers may not allow an extension of trade credit terms as the business is seen as too much of a risk
- Making use of short-term borrowing options such as overdrafts can improve a businesses working capital situation but relatively high level of interest must be paid
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- Holding large amounts of cash may mean missing out on benefits of investing it in fixed assets or investments
- This may represent a significant [popover id="rwgdJTaybPhZJ4sJ" label="opportunity cost"], as the money is not being put to work for the business
- If a business is holding large amounts of stock, it may incur extra storage costs, and the cash value of the stock could be used for other purposes
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