Working capital constitutes the capital that is needed in order for a company to run smoothly. Although it is obviously important in a business, it has to be managed properly or else disadvantages will arise due to having too much or too little working capital. When working capital is in excess there is no interest earned on it. Having limited working capital makes it hard for a business to meet all its obligations and take advantage of opportunities that can generate profit.
According to Sagner (2010), excess working capital hinders financial performance as it does not bring any return on equity. Having too much working capital does not allow for it to grow as it is just sitting and not serving any purpose which there for brings in zero return. It would make more sense for the business to invest this capital so that it may earn some interest.
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According to Sarfo (N.d), having limited working capital makes it difficult for a business to settle short term debts. This could be detrimental to the running of the business, for instance if the company requires a certain component in order to produce a final product but is unable to settle outstanding debts it may not be able to procure this component. This could lead to loss of business. According to Duarte (2014), having working capital that is too little can hinder chances to bring in possible profits. A company can find an opportunity to either produce or offer services that can bring in a lot of revenue but without adequate working capital this cannot be possible.
Response to Ruksaar Bashir
Thank you for your post. Working capital indeed helps a business to meet its daily expenses as it operates. Too little working capital is a disadvantage especially in the event of emergencies like in the example you have provided about injuries in a day care business. On the other hand, excess working capital could mean little productivity; it does not make much sense to have capital that lies idle without being of much benefit to a business. Perhaps someone might ask how much is too little or excess capital? How should this capital be balanced?
References
Duarte, N. (2014, Sept 23). Harvard Business Review . Business and Economics.
Sagner, J. (2010, July 10). Essentials of Working Capital Management.
Sarfo, E. (N.d). The Management of Working Capital . https://www.academia.edu/4726046/THE_MANAGEMENT_OF_WORKING_CAPITAL
