Excess working capital refers to more amount of working capital maintained than actually required. In other words, the quantum of excess working capital is the difference between the actual working capital and adequate working capital.
Disadvantages, Dangers or Limitations of excess working capital
The following are the dangers or limitations of excess working capital.
1. The business cannot earn a proper rate of return on its investment because excess capital does not earn anything for the business whereas the profits are distributed on the whole of its capital. Thus, the shareholders are getting less rate of return on their investments.
2. It leads to unnecessary purchase of inventories in bulk. This results in the inventory mishandling, waste, theft and losses increase.
3. It creates idle funds in a company. The company has to pay the interest for the loan amount acquired. But, the loan amount kept idle in the company.
4. The executives are not taking much interest on the collection from the debts. It leads to the higher incidence of bad debts adversely affects profits.
5. The sales department may follow liberal credit policy. It means that goods may be sold on credit for longer period.
6. It may motivate the Management to indulge in speculation activities which in turn may create more losses for the company.
7. It shows the inefficiency of the executives. Hence, their morality is affected at the maximum.
8. Excess availability of cash tempts the executives to spend more.
9. Whenever the rate of return is reduced, automatically the goodwill of the company will be affected.
10. Due to low return on investments, the value of shares may also fall.
11. Excess working capital destroys the control of turnover ratios very commonly used in conducting efficient business. It also destroys all other guides and sign posts in operating a business.