How does working capital affect both the liquidity as well as profitability of a business?
Answers
SOLUTION :
Working capital affect both the liquidity as well as profitability of a business by the following ways :
HIGH AMOUNT OF WORKING CAPITAL IMPROVES LIQUIDITY :
Excess of working capital than required maintain smooth flow of production by maintaining adequate amount of inventory and cash and bank balance. Thus , high amount of working capital improves liquidity.
HIGH AMOUNT OF WORKING CAPITAL REDUCES PROFITABILITY :
Excess of working capital than required creates idle funds, excessive inventory increases holding cost, High credit period to trade receivables loses returns on the funds blocked. Thus , excess amount of working capital Increase cost and reduces profitability.
Conclusion : Working capital should not be in excess or in deficit. Its optimum level should maintain with caution with timely inspection to maintain Ideal liquidity and higher profitability.
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