There is an optimum amount for working capital and it may be too high or too low. Too high working capital means inefficient use of funds, reflected in excessive inventories, accounts receivable or cash. It may also indicate an inability to obtain shares on credit. A WC too low means the inability to take advantage of the credit conditions offered with the loss of discount. Companies are engaged in "hand-to-mouth" purchasing and may be forced to rely on bank overdrafts and other credits, which is costly. This ratio is easily manipulated. For example, long-term borrowing to repay short-term debts will improve the ratio without being beneficial to the company.
Accounting - Topics - Understanding and using accounting information -
Is relevant as the denominator of ROI. (return on owner's investment) 
OE (owner's equity) is the residual value of assets minus liabilities. If
excess assets are carried by the business then OE is excessive and the
return on investment is diminished. To reduce OE the owner may dispose of
excess assets and take the excess funds out of the business and invest
elsewhere. Alternatively new, more productive assets may be acquired.
By diminishing the number of unnecessary assets the sales/assets ratio
will also be improved.
Previous | Next
Log in to save your progress and obtain a certificate in Alison’s free Fundamentals of Financial Accounting online course
Sign up to save your progress and obtain a certificate in Alison’s free Fundamentals of Financial Accounting online course
Please enter you email address and we will mail you a link to reset your password.