FACTORS DETERMINING WORKING CAPITAL
Working capital requirements of a concern depending on a number
of factors, each of which should be considered carefully for determining the
proper amount of working capital. These factors have been discussed below:-
Nature of Business:
The working capital requirements of an
enterprise are basically determined by the nature of its business. Trading
concerns invest a major part of their funds in inventories and bills receivable
and they also have to keep large amounts of cash. Conversely, the public
utility concerns like railways, electricity, insurance, etc., need relatively
much fewer inventories and cash. Manufacturing concerns stand in between these
two extremes. Working capital requirements of these concerns depend on a
number of factors including the nature of products, technology, marketing policies, etc.
Production Policies:
Production policies pursued by the
management constitute an important factor in determining the working capital
requirements of the firm. More working capital is required by those industries
which produce or sell goods in a particular season.
For example, the sugar and woolen textile industries require
more working capital in the winter season. Likewise, concerns engaged in the
manufacture of fans, refrigerators, water coolers, etc., undertake production the whole year, whereas sales take place only in the summer season. Such concerns of
seasonal nature also require more working capital.
Size of Business:
The amount of working capital also depends
upon the size of a business unit. Generally, large-scale concerns require more
working capital as than small concerns for maintaining big inventories
and carrying out business operations.
Length of Manufacturing Cycle:
The size of working capital
is also influenced by the length of the manufacturing cycle. The manufacturing process always involves a time lag between the time when raw materials are fed
into the production line and finished products are finally turned out by it. The
length of this period depends on the nature of products and production
technology used by a concern. The longer the manufacturing process, the higher will
be the requirements of working capital and vice versa. Generally, highly
capital-intensive industries need more working capital because of their highly
sophisticated and production process.
Credit Policy:
Almost all manufacturing companies and also
several trading companies use customer credit as one of their promotional
tools. Companies allowing liberal credit to their customers require more
working capital as against the companies which have efficient debt collection
machinery and observe strict credit terms. Similarly, working capital needs are
also determined by the credit facilities availed by a business concerned by its
suppliers. Liberal credit facilities from the suppliers of raw materials
inventories reduce the working capital requirements of concern to that extent.
A company that does not enjoy liberal credit facilities from its suppliers
will need more amount of working capital.
Turnover of Circulating Capital:
There is a high degree of
correlation between the quantum of working capital and the speed with which the
sales are affected. Companies with higher rates of turnover or faster sales will
need less amount of working capital as against
the companies with a low turnover ratio.
Business Fluctuations:
Cyclical changes also
influence the level of working capital. During the boom, the tendency of management
is to pile up inventories materials, and finished goods to avail the advantage
of rising prices This creates demand for more capital. Similarly, during the depression when the prices and demand for manufactured goods constantly reduce, industrial and trading activities show a downward trend. Hence, the demand for working capital is low.
Growth and expansion of Business:
In the beginning, the
working capital requirements of a company are low. However, with the gradual
growth and expansion, its working capital needs also increase. Discernibly, a large amount of working capital in a growing concern is required for its
expansion programs.
Economies of Scale:
The need for working capital is also
influenced by a company's desire to take advantage of the economies of scale.
In purchasing inventories, it balances the ordering costs against carrying
costs so as to arrive at the optimum order quality. Similarly, it balances the
transaction costs of borrowed funds against their interest costs.
Current Assets Policies:
The quantum of the working capital of a
company is significantly determined by its current asset policies. A company
with a conservative assets policy may operate with a relatively high level of
working capital than its sales volume. It may carry a larger volume of raw
materials and finished goods inventories, liberal terms of credit to its offer
customers, and carry a large amount of cash to meet its current expenditure. On
the contrary, a company pursuing an aggressive current assets policy operates
with a relatively lower level of working capital.
Fluctuations of Supply:
Certain companies have to maintain large reserves of raw materials due
to their irregular sales and intermittent supply. This is particularly true in the case of companies that require special kinds of materials available from limited
sources. Similarly, companies using bulky materials also maintain large reserves
of raw materials inventories. In the case of such companies, the working capital
requirements would be large.
Labor-intensive Vs. Capital-intensive Industries:
In the case
of labor-intensive industries, the working capital requirements be high due to
regular payments of heavy wage bills and overtime. On the other hand, highly
automatic and capital-intensive industries require a lesser amount of working
capital because of heavy investments in fixed assets and shorter time in the manufacturing process.
Seasonal Variations:
A number of industries manufacture and
sell goods only during certain seasons. For example, supplies of raw materials
or making their sales in a particular season. Hence, the working capital
requirements of such industries will be higher during a certain season as
compared to any other period.
Dividend Policy:
Dividend policy also influences the working
capital requirements of a business enterprise. If a company follows a
conservative dividend policy, more working capital would be required because
more funds would be needed for payment to the shareholders even if the
company's earnings are not sufficient to cover the such payment.
On the contrary, if a strict dividend policy is followed by
the management, less working capital will be needed by the management, and less
working capital will be needed by the concern. This is so because a portion of
the company's earnings may be retained in the business.
Other Factors:
Besides the above considerations, there are a
number of other factors which affect the working capital in a business concern.
Some of them are as follows-
(i) Effective
coordination between production and distribution policies will reduce the quantum of working capital
in a business concern.
(ii) Less developed
means of transportation and communication add to the quantum of working capital
of companies in such areas, because of stockpiling.
(iii) The magnitude
of working capital is also determined by the extent of hazards and
contingencies inherent in a particular type of business.
(iv) Absence of
specialization in the marketing of goodwill requires more working capital because
such concerns will have to their own marketing organizations.
(v) Companies which
have good banking connections and proved creditworthiness will require less
working capital as they can easily obtain the requisite funds from banks.
