January 26, 2022

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Balanced Working Capital Meaning and Key Explanations

Balanced Working Capital Meaning and Key Explanations
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Working capital management is an important part every finance manager must observe closely using statistical tools and personal judgement. More so, a balanced Working capital is what every business needs. Excessive or inadequate WC is bad for business. This article will discuss this in detail.

Definition of Balanced Working Capital

A balanced Working capital means a sound WC position. It also means a WC that is not too excessive and not inadequate. Here the company ensured there is a balance. Or let’s say, the business has a working capital that is just right. Another name for it is optimum working capital.

Key Explanations

In real life, it is not possible to have a balanced Working capital position on every business day. Therefore, there is a need for continuous checks on the entity’s working capital. An excessive WC may be good in some ways. Such as meeting debt obligations immediately. And attends to clients’ demands as they occur. However, it has its pitfalls.

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On the other hand, inadequate working capital is bad for business in all ramifications. It is better to have excess in WC than the other way around. However, striving to have a balanced WC is the best for any entity. Inadequate WC can lead to a business downside. Such as liquidation or cutting down the number of products and staff of the entity. Inability to meet up operational obligations is another huge problem. If lenders and other creditors notice these traits, it will be difficult to obtain credit facilities.

However, a balanced Working capital is required by every business. This will help reduce to the greatest minimum the challenges of inadequate and excessive WC. These challenges included excessive inventories and stagnant growth. However, a balanced WC reduces risks in businesses.

Problems of inadequate working capital

Below are some challenges or disadvantages of inadequate working capital.

The entity will have more inventories and cash. These result in mishandling, waste, theft, and losses.
Excessive WC will make management slack in recovering debts. The result is bad debts. It makes the company lose most of its revenue to impairments (that is, bad debts).
It will encourage management to speculate high profit. However, if adequate marketing is not followed to increase sales, the entity will not meet up its speculated profit. This will lead to management inefficiency.

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Disadvantages of inadequate working capital

Here are some challenges of inadequate working capital

Stagnant growth for the entity. It will be difficult for the business to grow because of a lack of finance to undertake new profitable projects.
There is a lack of funds to meet operational expenses. Including fueling the entity’s plants and vehicles. Lack of funds to repair vehicles leads to low sales and decreased customers’ confidence in the entity.
It results in operational inefficiencies. Why? The entity can not meet its day-to-day commitments.
If lenders and creditors are aware of the negative working capital, it will be difficult for the business to access credit facilities.
The business may short down as a result. Especially if their clients and customers are aware of it. They won’t want to do business with the entity. This will result in the total collapse of the firm.

Conclusion

Balanced Working capital helps mitigate against the disadvantages of inadequate and excessive wc of an entity. Therefore, the management of an entity must strive to optimize its WC position.

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