Over-Capitalisation in Cash Management

tawny

Hello
I'm struggling to understand the concept of over-capitalisation. I understand that it's where the company has too much cash. I don't understand the bit in my textbook where it says 'Consequently profit is suppressed in relation to capital investment in the company and earnings per £ of capital are low'.
Can anybody help to explain what it means please?
Thanks in advance

richf

Not sure which module your doing, and don't remember reading about this.

But just reading what you have written I'd say it simply means that having two much capital used, ie more than needed, means you will have less profit relative to capital in use? If you look at the ROCE formula you see why.

Apologies if I've misunderstood, doesn't sound like something I've been taught yet.

CeeJaySix

If you have cash just sitting in the bank, it's not earning any money.

Capital = Net Assets, as I'm sure you're aware - your bank balance is part of those net assets.

As Rich alludes to, a common key performance indicator is return on capital invested. If you have a lot of cash, there must be the equivalent capital invested (else the equation wouldn't balance). If that cash isn't being used in operations - ie. to generate profit - you are not seeing an increase in return on that capital corresponding to the level of cash.

Time to invest the surplus - expansion, or non-trading investments - or return it to the shareholders - dividends.

richf

And that's why I hate answering wordy questions lol.... I can't make myself both clear enough and give full enough answers!