What Does Excess Working Capital Mean?
Excess working capital means that the working capital of a company is higher than the norm. Working capital means the amount of current assets that exceed the current liabilities of a company. Since working capital is the heart of any business, both deficit and excess working capital can have serious implications for the financial health and operational ability of firms.
Divestopedia Explains Excess Working Capital
Excess working capital is not all about current assets, rather it is current assets minus current liabilities. This inclusion of liabilities makes it that much more difficult to determine how much of the working capital is non-operational since the excess can be due to both high assets and low liabilities. Also, different industries need different amounts of working capital, so what is excess for one may not be excess for another. Such an example is a seasonal business that needs different amounts of working capital throughout different times of the year.
Excess working capital overall, though, is bad because it means that the amount of money available within the company is much more than what it needs for its operations. This is a waste of money and it becomes a type of non-operating asset. This excess money could be diverted towards more productive aspects that can increase the revenue earning potential of the company. Also, when this excess working capital is used productively, it can increase the return for investors and the overall value of the share will increase in the stock market. On the other hand, this excess capital is detrimental to the company because unused funds will bring no revenue for the company and this, in turn, will lead to a fall in the share prices.
Another problem with excess capital is reduced efficiency within the management team. When a company has more funds than it needs, the management tends to get complacent, which can reduce efficiency. Over time, this can also decrease investors' confidence in the management team to successfully handle the finances.
In an M&A transaction, if a company operates with excess working capital, it may be difficult to convince a prospective buyer that the company does not require all of the working capital within the business at the time of closing. This will directly impact the amount of cash on a dollar for dollar basis that the selling shareholder will be able to extract from a business prior to a sale.