Question

Your Financial Analysis Lecture made the statement quoted below. Assume Simmi Company, a computer hardware manufacturer, has a high working capital because current assets include a high cash balance. (You may select either (1) or (2) below to answer.) (1) How could a firm have too much working capital? Isn't working capital a good thing? (2) There may be a number of sound business reasons that Simmi Company has a high cash balance at this point in time. What might that reason be?

Answer 1

1)	Working capital (net) refers to the total of current assets as
	reduced by the current liabilities.
	Current assets include mainly cash, inventories and debtors.
	A firm may carry more cash or inventory or debtors than what
	is actually required or justified, thereby leading to too much
	of working capital. While adequate working capital is necessary, too
	much is harmful, as it will lead to higher financing charges
	and also losses in realization.
	Idle cash does not generate earnings. Similarly too much of
	investment in inventories only increases holding costs and higher
	investment in receivables will entail higher financing charges
	and might result in bad debt losses. Hence, though working capital
	is a good thing, too much is harmful.
	Higher investment in inventory may be due to carrying higher stocks
	or may be due to presence of obsolete or non-moving inventory.
	Higher receivables might be due to granting of higher credit period
	and/or also poor credit and collection policy.