Accounting - Liquidity ratios
There is an optimum amount for working capital and it may be too high or
too low. A working capital (WC) that is too high means an inefficient use
of funds, reflected by excessive stock, debtors or cash. It may also
indicate an inability to obtain stock on credit.
A WC that is too low means the inability to take advantage of credit terms
offered with the loss of discount. Businesses are engaged in 'hand to
mouth' buying and may be forced to rely on bank overdrafts and other
credit, which is expensive.
This ratio is easily manipulated. For instance, borrowing long term to
repay short term debts will improve the ratio without being of benefit to
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