## Importance of Adequate Working Capital
| Consequence | Too Little WC | Too Much WC |
|---|---|---|
| Operations | Cannot pay wages/buy materials | Smooth but funds idle |
| Profitability | Lost sales opportunities | Reduced return on capital |
| Solvency | Risk of insolvency, loss of reputation | Over-leveraged short-term |
| Interest cost | N/A | Higher carrying cost / opportunity cost |
Bottom line: WC must be adequate — neither excess nor deficient.
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## Optimum Working Capital
- Definition: Enough WC to meet obligations without excess idle funds.
- Target ratios:
- Current Ratio = 2:1 (ideal)
- Quick Ratio = 1:1 (ideal)
- Note: Businesses with fast-moving inventory or rapid debtor recovery may operate efficiently at lower ratios.
Outcomes of proper WC management:
- Better creditworthiness with banks and suppliers
- Stable liquidity position
- Higher efficiency and profitability
- Enhanced business reputation
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## Determinants of Working Capital
| Factor | Impact on WC |
|---|---|
| Cash needs | Higher daily operating expenses → more WC |
| Inventory level | More inventory (JIT reduces this) → more WC |
| Receivables / credit policy | Liberal credit → higher debtors → more WC |
| Short-term financing options | Easier access to credit → less internal WC needed |
| Nature of business | Cash-based (restaurants) → low WC; inventory-heavy (pharmacies) → high WC |
| Market/demand conditions | Fast-moving goods → lower WC; slow/uncertain sales → higher WC |
| Technology/manufacturing policy | Continuous production → high inventory WC; seasonal production → temporary WC spikes |
| Operating efficiency | Better efficiency (less wastage, faster cycle) → lower WC |
| Price level / inflation | Rising prices → more WC needed to maintain same physical volumes |
| Exchange rate fluctuations | Import costs rise with weak rupee → higher WC for raw materials |