What are the Risks of Inadequate Working Capital?

Banking & FinanceFinance ManagementGrowth & Empowerment

What is a Working Capital?

Working capital is the fuel for running businesses the companies. It may be stated that maintaining an adjusted amount of working capital is the first and foremost aim of business organizations. While having too much working capital is bad, an inadequate amount of working capital can create problems in running the businesses smoothly as well.

While having too much working capital is bad, having too low working capital is also a sign of weakness of a business firm. In order to keep the business running on a smooth path, the firm must maintain a healthy amount of working capital.

Risks of Having Inadequate Working Capital

Some of the risks of having inadequate working capital are as listed below.

Stagnation of growth

An inadequate amount of working capital stagnates the growth prospects of an organization. As the company cannot invest in profitable ventures with an adequate amount of working capital, its prosperity, and growth if affected. Firms that have inadequate working capital find it difficult to undertake profitable projects which affect their revenues and profitability directly. That is why having enough working capital to meet the needs of the business is necessary.

Difficulty in Meeting Targets

Firms with inadequate working capital find it difficult to meet business targets due to a lack of funds. Firms that have inadequate working capital may have to face a shortage of funds when they actually need it. Therefore, they may miss the targets of growth in business. Maintaining a solid amount of working capital is, therefore, necessary to meet business targets.

Operating Inefficiency

Businesses may fail to meet the day-to-day needs for tuning the businesses when they have an inadequate amount of working capital. This may lead to operating inefficiency. When there is no fund to meet the general expenses of a firm, the firm may find it tough to meet the expenses that are needed for smooth operations.

This may derail the firm from the path of smooth business as they may have to resort to loans from time to time. An extreme lack of working capital may even halt the business operation leading to losses and bankruptcy at the extreme.

Deterioration of Profitability

In the case of a lack of working capital, fixed assets of a firm may not be properly utilized. This may result in a lack of profitability. To stay competitive and profit from its operations, a firm must use its fixed assets.

However, if there is a shortage of working capital, the firms may not be efficient in utilizing the fixed assets. This hampers the quality of operations, leading to losses and hampering the overall profitability of an organization.

Missing Attractive Opportunities

Having low working capital renders a firm miss profitable opportunities, such as credit opportunities. As the firm struggles to meet its targets, it cannot look for attractive options and had to focus on increasing the working capital funds.

Therefore, having low working capital can strike the business where it can benefit from opportunities that may be profitable for them.

Loss of Reputation

A firm lacking in working capital cannot maintain a good financial reputation as it cannot manage its business as the lenders want. Therefore, it may have to face tougher credit restrictions. Loss of reputation also lands it in trouble while raising funds for operation. So, it falls into a vicious cycle where it is in trouble from all angles.

Conclusion

For a business firm, it is ideal to have a proper amount of working capital all the time. It is the duty of management to judge the right amount of working capital for running the organization and keep the adequate amount of working capital available for the firm to stay competitive in the business operations.

raja
Updated on 29-Jun-2022 13:19:50

Advertisements