Factors Affecting Working Capital requirements [Financial Management Notes for NEP and CBCS Pattern]

Factors Affecting Working Capital requirements
[Financial Management Notes for NEP and CBCS Pattern]

Factors Affecting Working Capital Requirements

The level of working capital is influenced by several factors which are given below:

a)      Nature of Business: 

Nature of business is one of the factors. Usually in trading businesses the working capital needs are higher as most of their investment is found concentrated in stock. On the other hand, manufacturing/processing business needs a relatively lower level of working capital.

b)      Size of Business: 

Size of business is also an influencing factor. As size increases, an absolute increase in working capital is imminent and vice versa.

c)       Production Policies: 

Production policies of a business organisation exert considerable influence on the requirement of Working Capital. But production policies depend on the nature of product. The level of production, decides the investment in current assets which in turn decides the quantum of working capital required.

d)      Terms of Purchase and Sale: 

A business organisation making purchases of goods on credit and selling the goods on cash terms would require less Working Capital whereas an organisation selling the goods on credit basis would require more Working Capital. If the payment is to be made in advance to suppliers, then large amount of Working Capital would be required. 286

e)      Production Process: 

If the production process requires a long period of time, greater amount of Working Capital will be required. But, simple and short production process requires less amount of Working Capital. If production process in an industry entails high cost because of its complex nature, more Working Capital will be required to finance that process and also for other expenses which vary with the cost of production whereas if production process is simple requiring less cost, less Working Capital will be required.

f)       Turnover of Circulating Capital: 

Turnover of circulating capital plays an important and decisive role in judging the adequacy of Working Capital. The speed with which circulating capital completes its cycle i.e. conversion of cash into inventory of raw materials, raw materials into finished goods, finished goods into debts and debts into cash decides the Working Capital requirements of an organization. Slow movement of Working Capital cycle requires large provision of Working Capital.

g)      Dividend Policies: 

Dividend policies of a business organisation also influence the requirement of Working Capital. If a business is following a liberal dividend policy, it requires high Working Capital to pay cash dividends where as a firm following a conservative dividend policy will require less amount of Working Capital.

h)      Seasonal Variations: 

In case of seasonal industries like Sugar, Oil mills etc. More Working Capital is required during peak seasons as compared to slack seasons.

i)        Business Cycle: 

Business expands during the period of prosperity and declines during the period of depression. More Working Capital is required during the period of prosperity and less Working Capital is required during the period of depression.

j)        Change in Technology: 

Changes in Technology as regards production have impact on the need of Working Capital. A firm using labour oriented technology will require more Working Capital to pay labour wages regularly.

k)      Inflation: 

During inflation a business concern requires more Working Capital to pay for raw materials, labour and other expenses. This may be compensated to some extent later due to possible rise in the selling price. 287

l)        Turnover of Inventories: 

A business organisation having low inventory turnover would require more Working Capital where as a business having high inventory turnover would require limited or less Working Capital.

m)    Taxation Policies: 

Government taxation policy affects the quantum of Working Capital requirements. High tax rate demands more amount of Working Capital.

n)      Degree of Co-ordination: 

Co-ordination between production and distribution policies is important in determining Working Capital requirements. In the absence of co-ordination between production and distribution policies more Working Capital may be required.