Q6 of 18 Page 254

How does working capital affect both the liquidity as well as profitability of a business?

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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Aval Ltd. is engaged in the business of export of canvas goods and bags. In the past, the performance of the company had been upto the expectations. In line with the latest demand in the market, the company decided to venture into leather goods for which it required specialised machinery. For this, the Finance Manager Prabhu prepared a financial blueprint of the organisation’s future operations to estimate the amount of funds required and the timings with the objective to ensure that enough funds are available at right time. He also collected the relevant data about the profit estimates in the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources of the business. For the remaining funds, he is trying to find out alternative sources from outside.

a. Identify the financial concept discussed in the above paragraph. Also, state the objectives to be achieved by the use of financial concept so identified. ( Financial Planning).


b. ‘There is no restriction on payment of dividend by a company’. Comment. ( Legal & Contractual Constraints)


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What is working capital? How is it calculated? Discuss five important determinants of working capital requirement.