Page 12 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 1: Introduction to Working Capital Management

1.3 Factors Affecting Working Capital Requirements Notes

The working capital requirement of a concern depends upon a large numbers of factors such as
nature and size of business, the character of their operations, the length of production cycles, the
rate of stock turnover and the state of economic situation. It is not possible to rank them because
all such factors of different importance and the influence of individual factors changes for a firm
overtime. However the following are important factors generally influencing the working
capital requirement:

1. Nature or Character of Business: The working capital requirement of a firm basically
depends upon the nature of this business. Public utility undertakings like electricity water
supply and railways need very limited working capital because they offer cash sales only
and supply services, not products and as such no funds are tied up in inventories and
receivables. Generally speaking it may be said that public utility undertakings require
small amount of working capital, trading and financial firms require relatively very large
amount, whereas manufacturing undertakings require sizable working capital between
these two extremes.

2. Size of Business/Scale of Operations: The working capital requirement of a concern is
directly influenced by the size of its business which may be measured in terms of scale of
operations.

3. Production Policy: In certain industries the demand is subject to wide fluctuations due to
seasonal variations. The requirements of working capital in such cases depend upon the
production policy.
4. Manufacturing Process/Length of Production Cycle: In manufacturing business the
requirement of working capital increases in direct proportion of length of manufacturing
process. Longer the process period of manufacture, larger is the amount of working capital
required.

5. Seasonal Variation: In certain industries raw material is not available through out the
year. They have to buy raw materials in bulk during the season to ensure and uninterrupted
flow and process them during the entire year.
6. Rate of Stock Turnover: There is a high degree of inverse co-relationship between the
quantum of working capital; and the velocity or speed with which the sales are affected.
A firm having a high rate of stock turnover will need lower amount of working capital as
compared to affirm, having a low rate of turnover.

7. Credit Policy: The credit policy of a concern in its dealing with debtors and creditors
influence considerably the requirement of working capital. A concern that purchases its
requirement on credit and sell its products/services on cash require lesser amount of
working capital.

8. Business Cycle: Business cycle refers to alternate expansion and contraction in general
business activity. In a period of boom i.e., when the business is prosperous, there is a need
of larger amount of working capital due to increase in sales, rise in prices, optimistic
expansion of business contracts sales decline, difficulties are faced in collection from
debtors and firms may have a large amount of working capital lying idle.
9. Rate of Growth of Business: The working capital requirement of a concern increase with
the growth and expansion of its business activities. Although it is difficulties to determine
the relationship between the growth in the volume of business and the growth in the
working capital of a business, yet it may be concluded that of normal rate of expansion in
the volume of business, we may have retained profits to provide for more working capital
but in fast growth in concern, we shall require larger amount of working capital.

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