Examine the key reasons why a business may not want to hold too much or too little working capital.
- Examine the key reasons why a business may not want to hold too much or too little working capital. Provide examples that illustrate the consequences of either situation.
Businesses will not want to hold too much working capital because it will lead to a higher amount of cash on hand for the business and it can lead to a lack of investment and loss of opportunities, so the business will be facing a lot of flack from shareholders as they are not distributing the dividend or they are not investing into the business.
Businesses who are trying to hold too little working capital have a higher amount of profitability and they will not be looking for profitability, so they will be facing problems concerning lower liquidity and they will have a risk associated with a higher cost of financial distress because they will not be able to meet the debt repayment.
When the businesses have a high amount of cash, current assets, and net working capital then it means that the company is highly conservative and it is not taking a risky position in order to maximize the rate of return and it will lose out on various opportunities. Whereas, if the company has an excessive amount of profit-making and it will not have a higher amount of net working capital and it will have a risk associated with financial distress because any default can trigger financial distress because the company will be invested into the business through funding of the current asset.
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