Working Capital Meaning
Working capital as the name suggests refers to that capital which is needed for the working of the company and without this capital, a company will not be able to function smoothly. It is calculated as current assets less current liabilities, a positive working capital implies that a company has been successful in paying off short-term liabilities and is generally considered as a good sign while a negative working capital implies that a company has been unsuccessful in paying off short-term liabilities and is generally considered a bad sign. In order to understand more about this concept, one should look at the advantages and disadvantages of working capital –
Advantages of Working Capital
Helps in Running Business Smoothly
The biggest advantage of this capital is that it helps the company in running the business effectively and smoothly because imagine a situation where the company does not have working capital than it won’t be able to pay the salaries of the employees, pay to the suppliers for the raw material or pay regular administrative expenses on time leading to complete breakdown as without men, machine and raw material a company is like body without any soul.
Goodwill of the company
It also helps in maintaining the goodwill of the company because if outside parties like creditors, suppliers, employees come to know about the companies poor working capital they will not be interested in working with company and it will turn into a vicious cycle because less working capital would mean less business which in turn will lead to even lesser working capital.
Helps in Bargaining
In business cash is king and a company which has enough working capital can bargain and get things on its terms rather than others dictating the terms to the company. Hence for example, if the company goes for purchasing raw material from suppliers than 99 percent of the time if the company is willing to pay them in advance they will be willing to offer a discount the as opposed to those companies who take raw materials on credit.
Disadvantages of Working Capital
No return on Capital
The biggest disadvantage of this capital is that all the excess working capital lying with the company earns no interest and therefore it can be termed as zero return capital. Capital has an opportunity cost and if the company has locked too much capital into working capital than it is not a prudent financial decision on the part of the company. Hence in simple words a company has to maintain fine balance when it comes to managing this capital as more working capital than required also is not a good sign as far as the company is concerned.
Chances of Overspending
Another drawback of this capital is that if the company has excess capital than chances are that the company will end up spending or purchasing those things which are not necessary for the business. Hence in simple words purchasing unnecessary things due to excess capital is one of the limitations of having working capital with the company.
No Bifurcation
Another risk associated with working capital is that companies tend to use the working capital for financing long-term projects and thus there is no bifurcation between short term and long term method of financing. In simple words just like one antibiotic cannot be used to treat all diseases in the same way working capital cannot be used to fund all types of expenses which some companies tend to do and jeopardize the short-term financial position of the company.
As one can see from that working capital have advantages as well as disadvantages and any company thinking of having working capital for business should carefully read above points and then decide how much of this capital it should have at any point of time because having too less or too much of this capital can be detrimental for the business of the company.