Page 212 - DMGT405_FINANCIAL%20MANAGEMENT

Financial Management

Notes 10.1.1 Factors Affecting Working Capital

The important factors are:
1. General Nature of Business: In some organizations, the sales are mostly in cash basis and
the operating cycle (explained) later is also short. In these concerns, the working capital
requirement is comparatively low. Mostly, service companies come under this category.
In manufacturing companies, usually the operating cycle is very long and a firm is also
required to give credit to customers to boost sales. In such cases, working capital
requirement is high. Similarly, a trading concern requires lower working capital than a
manufacturing concern.
2. Production Policy: Working capital requirements also fluctuate according to production
policy adopted by the company

Example: In case of products having seasonal demand a steady production can be
planned throughout the year in which case finished goods are to be kept for a longer
period. The other alternative is to produce only during the season in which case raw
materials have to be accumulated throughout the year.
3. Credit Policy: A company, which allows liberal credit to its customers, may have higher
sales, but consequently will have larger amount of funds tied up in sundry debtors. Similarly
a company, which has very efficient debt collection machinery and offers strict credit
terms, may require lesser amount of working capital that the one where debt collection
system is not so efficient where the credit terms are liberal.

The creditability of a company in the market also has an effect on the working capital
requirement. Reputed and established concern can purchase raw material on credit and
enjoy many other services like door delivery after sales service, etc., This would mean that
they could easily have large current liabilities.
4. Inventory Policy: The inventory policy of a company also has an impact on the working
capital requirements. An efficient firm may stock raw material for a smaller period and
may, therefore, require lesser amount of working capital.

5. Abnormal Factors: Abnormal factors like strikes and lockouts require additional working
capital. Recessionary conditions necessitate a higher amount of stock of finished goods
remaining in stock. Similarly, inflationary conditions necessitate more funds, to maintain
the same amount of current assets.
6. Market Conditions: In case of competitive pressure, large inventory is essential, as delivery
has to be off the shelf or credit has to be extended on liberal terms.
7. Conditions of Supply: If prompt and adequate supply of raw materials, spares, stores, etc.,
is available it is possible to manage with small investments in inventory or work on Just-
In-Time (JIT) inventory principles. However, if supply is erratic, scant, seasonal, channelised
through government agencies etc. it is essential to keep larger stocks increasing working
capital requirements.
8. Business Cycle: Business fluctuations lead to cyclical and seasonal changes in the production
and sales and affect the working capital requirements.
9. Growth and Expansion Activities: The working capital of the firm increases as it grows in
terms of sale or fixed assets.
10. Level of Taxes: The amount of taxes to be paid is determined by the prevailing tax
regulations. Very often taxes have to be paid in advance on the basis of the profit of the

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