HOW DOES WORKING CAPITAL AFFECT

BOTH THE LIQUIDITY AND

PROFITABILITY OF BUSINESS?

By Dr. Preeti Jindal

Qualification: M.Com, Ph.D, UGC-NET & JRF
Importance of Topic
 This topic is of great importance for commerce and
management students at UG & PG level.
 It is also vital for those who are preparing for
competitive exam like UGC-NET & JRF.
Discussion
 Let’s start with what is working capital.
 Working capital is that capital which is used in day to
day trading operations of a business.
 In accounting terms, working capital can be calculated
as:
 Working Capital= Current Asset-Current Liabilities.
 Current assets include Cash, Stock, Debtors etc.
 Current liabilities include Bank overdraft, creditors,
outstanding expenses.
 Now the question arises how we can make
available working capital into the business.
 It is with the help of long term sources, say shares,
debentures and loans, working capital is acquired.
 Working capital neither should be too large nor
should be too small. If it doesn’t so it could affect
liquidity and profitability of the business adversely.
 With the help of following chart we can see how
working capital affect liquidity as well as
profitability of the business.
Y Y

Liquidity
Profit-
ability
o O
Working X Working Capital X
Capital
 See if working capital is large the liquidity position would improve,
but profitability would be adversely affected as funds will remain
idle. On the other hand, if the working capital is relatively small, the
overall profitability will no doubt increase, but it will have an adverse
effect on the liquidity position and make the firm risk-prone. So
working capital should be maintained at such level that a trade off
between liquidity and profitability can be attained. As shown in the
following chart.
Y

Liquidity
& profitability

O X
Working Capital
Conclusion
 It is concluded that amount of working capital
invested in the business affects the liquidity as well
as profitability of the business. Therefore, working
capital should be at optimum level while
maintaining trade off between profitability and
liquidity.
Thank You