Page 33 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes working capital requirements of a business are, thus, affected by the terms of purchase and sale,
and the role given to credit by a company in its dealings with creditors and debtors.
The prevailing trade practices as well as changing economic conditions affect credit terms fixed
by an enterprise. If, for example, competition is keen, there would be pressure to grant generous
credit terms. Nevertheless, there is wide scope for managerial discretion in working out a
suitable credit policy relevant to each customer based on the merits of each case. For instance,
liberal credit facilities can be extended on the basis of credit rating. This will avoid the problem
of having excess working capital. Similarly, the collection procedure can be so framed that
funds, which would otherwise be available for meeting operating needs are not locked up. Thus,
adoption of rationalised credit policies would be a significant factor in determining the working
capital needs of an enterprise.

Such discretion may, however, not be available to a company which operates in a highly
competitive market. To win and retain customers, it may be forced, among other things, to offer
generous credit terms to them. The investment in book debts will consequently be of a higher
order, necessitating large working capital in another way. To be able to enjoy consumer patronage
on a continuous basis, a firm will have to offer a variety of products quite unlike a firm which
has a hold on the market and, hence, does not need special efforts to satisfy customer requirements.
The consequence of a higher level of inventories would be an additional need for working
capital. The degree of competition is, therefore, an important factor influencing “working capital
requirements”.

Growth and Expansion

As a company grows, it is logical to expect that a larger amount of working capital is required.
It is, of course, difficult to determine precisely the relationship between the growth in the
volume of business of a company and the increase in its working capital. The composition of
working capital in a growing company also shifts with economic circumstances and corporate
practices. Other things being equal, growth industries require more working capital than those
that are static. The critical fact, however, is that the need for increased working capital funds
does not follow the growth in business activities but precedes it. Advance planning of working
capital is, therefore, a continuing necessity for a growing concern. Or else, the company may
have substantial earnings but little cash.

Vagaries in the Availability of Raw Material

The availability or otherwise of certain raw materials on a continuous basis without interruption
would sometimes affect the requirement of working capital. There may be some materials,
which cannot be procured easily either because of their sources, are few or they are irregular. To
sustain smooth production, therefore, the firm might be compelled to purchase and stock them
far in excess of genuine production needs. This will result in an excessive inventory of such
materials. The procurement of some essential raw materials is difficult because of their sporadic
supply. This happens very often with raw materials which are in short supply and are controlled
to ensure equitable distribution. The buyer has in such cases very limited options as to the
quantum and timing of procurement. It may so happen that a bulk consignment may be available
but the firm may be short of funds, while when surplus funds are available the commodities
may be in short supply. This element of uncertainty would lead to a relatively high level of
working capital. Finally, some raw materials may be available only during certain seasons.
They would have to be necessarily obtained when available, to provide for a period when
supplies are lean. This will cause seasonal fluctuations in working capital requirements.

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