Working capital = Current Assets – Current Liabilities
A high amount of working capital compared to industry averages suggests that the organization may not be efficiently using its resources. This could mean that:
Excess cash is invested in inventory or accounts receivable, instead of being used for growth, investment, or shareholder returns.
The company may be holding too much inventory, which could lead to obsolescence or additional storage costs.
The business may have slow turnover in receivables, meaning cash is not being collected efficiently.
A. Settlement of short-term obligations may become difficult. (Incorrect)
A high working capital means the organization has sufficient assets to cover short-term obligations, so liquidity issues are unlikely.
B. Cash may be tied up in items not generating financial value. (Correct)
High working capital may indicate inefficient use of assets, such as excess inventory, high accounts receivable, or idle cash.
This can negatively impact return on assets (ROA) and overall financial performance.
C. Collection policies of the organization are ineffective. (Incorrect)
While high receivables can be a factor, working capital includes all current assets and liabilities, not just accounts receivable.
The issue could be inventory mismanagement or excess liquidity, not just collection policies.
D. The organization is efficient in using assets to generate revenue. (Incorrect)
A high working capital does not necessarily mean efficiency. In fact, it may indicate underutilized resources rather than optimized performance.
IIA GTAG 3 – Continuous Auditing: Implications for Internal Auditors highlights the importance of monitoring key financial metrics such as working capital.
IIA Practice Advisory 2130-1 – Assessing Organizational Performance emphasizes that internal auditors should assess whether financial resources are being used efficiently.
Financial Management Principles (IIA Guidance) discuss the impact of excessive working capital on liquidity and return on investment.
Explanation of Answer Choices:IIA References:Thus, the correct answer is B. Cash may be tied up in items not generating financial value.
