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Question
How does working capital affect both the liquidity as well as profitability of a business?
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Solution
Working capital is the difference between current assets and current liabilities. It affects both liquidity and profitability of the business.
- The increase in current assets increases the liquidity position of the business but affects the profitability adversely because the return on current assets is quite low.
- Low working capital will affect the liquidity of the business which may disturb the day to day operation.
So the working capital should be maintained at such a level that a proper balance could be maintained between profitability and liquidity.
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