DETERMINENTS OF WORKING CAPITAL

abhishreshthaa

New member
DETERMINENTS OF WORKING CAPITAL


1. Nature of Industry

The composition of current assets is a function of the size of a business and the industry to which it belongs. Small companies have smaller proportion of cash receivables and inventory than large corporations

This difference becomes more marked in large companies. For e.g. A public utility concern mostly employs fixed assets in its operations, while a merchandising department depends generally on inventory and receivables. Needs for working capital are thus determined by the nature of an enterprise.


2. Size of the Business

The size of the business has also an important impact on its working capital needs. Size may be measured in terms of a scale of operation. A firm with larger scale of operation will need more working capital than a small firm.


3. Manufacturing Cycle

Longer the manufacturing process, the higher will be the requirements of working capital and vice versa. This is because of the fact that highly capital intensive industries require a large amount of working capital to run their sophisticated and long production process. On the same principle, a trading concern requires a much lower working capital than a manufacturing concern.


4. Production Policy

The production policies pursued by the management have a significant effect on the requirements of the working capital of the business. The production schedule has a great influence on the level of inventories. The decision of the management regarding automation, etc, will also have its effect on working capital requirements. In case of labour intensive industries the working capital requirements will be more. While in case of a highly automatic plant, the requirements of long term funds will be more.



5. Volume of sales

This is the most important factor affecting the size and components of the working capital. A firm maintains current assets because they are needed to support the operational activities which result in sales. The volume of sales and the size of the working capital are directly related to each other. As the volume of sales increases, there is an increase in the investment of working capital.


6. Terms of Purchases and Sales

A firm which allows liberal credits to its customers may enjoy higher sales but will need more working capital as compared to a firm enforcing strict credit terms. The working capital requirements are also affected by the credit facilities enjoyed by the firm. A firm enjoying liberal credit facilities from its suppliers requires, lower amount of working capital as compared to a firm which does not enjoy any such liberal credit facilities.


7. Business Cycles

Business expands during the period of prosperity and declines during the period of depression. Consequently, more working capital is required during the period of prosperity and less during the period of depression. Seasonal fluctuations not only affect the working capital requirements but also create production problems for the firm. Therefore, financial arrangements for seasonal working capital requirements can be made in advance. However, the financial plan or arrangements should be flexible enough to take care of some abrupt seasonal fluctuations.



8. Fluctuations in the Supply of Raw Materials

Certain companies have to obtain and maintain large reserves of raw materials due to their irregular sales and intermittent supply. This is particularly true in case of companies requiring special kind of raw materials available only from one or two sources. In such a case a large quantity of raw materials has to be kept in store to avoid any possibility of the production process coming to a dead halt. Thus, the working capital requirements in case of such industries would be large.


9. Price Level Changes

The increasing shifts in price levels make the function of the financial manager difficult. He should anticipate the effect of price level changes on working capital requirements of the firm. The companies which can immediately revise their product prices with rising price levels will not face severe working capital problems. Thus the effects of rising prices will be different for different companies. Some will not have to face the working capital problems while the working problems of others may be aggravated.



10. Operating Efficiency

The operating efficiency of the firm relates to the optimum utilization of resources at minimum cost. The firm will be effectively contributing to its working capital if it is efficient in controlling the operating costs.


11. Profit Margin

Firms differ in their capacity to generate profit from business operations. Some firms enjoy a dominant position, due to quality product or good marketing management or monopoly power in the market and earn a high profit margin. Some other firms may have to operate in an environment of intense competition and may earn low margin of profits. A high net profit margin contributes towards the working capital pool. In fact, the net profit is a source of working capital to the extent it has been earned in cash.


12. Profit Appropriation

If net profits are earned in cash at the end of the period, whole of it is not available for working capital purposes. The contribution towards working capital would be affected by the way in which profits are appropriated. The availability of cash generated from operations thus, depend upon taxation, dividend and retention policy and depreciation policy.



13. Credit Policies of Reserve Bank of India
If the Reserve Bank of India follows selective and restrictive credit policies, the working capital position becomes difficult. Suppliers insist on advance payments, while it will be difficult to sell, unless competitive credit terms are offered to the customers.


14. Capital Structure of the Company

If the share holders have provided some funds towards the working capital needs also (at least to satisfy the permanent working capital needs) the management will find it relatively easy to manage working capital. If the company has to depend entirely upon outside sources for both permanent and temporary working capital needs, it faces an uphill task under dear money conditions.
 
Top