Page 146 - DMGT409Basic Financial Management

Unit 8: Working Capital Management

fixed assets, but they require more working capital. In contrast, public utility concerns Notes
rendering public services require huge investment in fi xed assets.
2. Size of Business: It may be argued that a firm’s size, measured in terms of assets or sales,

affects need for working capital. Size may be measured in terms of a scale of operation.

A firm having with large-scale operations will need more working capital required then
a small firm having small-scale operations. A small firm may use extra current assets as a

cushion against cash fl ow interruptions.
3. Production Cycle Process: This is another factor, which has bearing on the quantum of
working capital, is the production cycle. The term production or manufacturing cycle refers
to the time involved in the manufacturing of goods. It covers the time span between the
procurement of raw materials and the completion of the manufacturing process leading
to the production of finished goods. Longer the production cycle, the higher will be the

working capital requirement and vice versa.
5. Credit Policy or Terms of Purchase and Sales: The credit policy relating to sales and
purchases also affects the working capital. If a company purchases raw materials in cash
and sells goods on credit, it will require larger amount of working capital. On the contrary,
a concern having credit facilities for the purchase of raw materials and allowing no credit
to its customers will require lesser amount of working capital.

6. Business Cycle: The amount of working capital requirements of a firm varies with every

movement of business cycle. The variations in business conditions may be in two directions
(a) Upward phase – when boom conditions prevail, in this case more working capital is
required to cover the lag between the increased sales and receipt of cash as well as to

finance purchase of additional material. (b) Downswing phase – in this case, the need for
working capital will be very less, since there is no growth in sales.
8. Scarce Availability of Raw Materials: The availability of certain raw materials on a
continuous basis without interruption would sometimes affect the working capital
requirement. There may be some materials, which cannot be procured easily either because

of either their sources are few or they are irregular. Therefore, the firm might be compelled
to purchase more than required to manage smooth production. In this case, the amount of
working capital required is large.

11. Dividend Policy: Dividend has a bearing on working capital, since it is appropriation
profits. The payment of dividend reduces cash resources and thereby, affects working

capital to that extent. Conversely, if the firm does not pay dividends but retains profi ts, the

working capital increases. In other words, declaration of dividends leads to more working
capital requirement and vice versa.
14. Operating Effi ciency: The operating efficiency of the firm relates to the optimum utilisation

of resources at minimum costs. Effi ciency of operations accelerates the pace of cash cycle
and involves the working capital turnover. In this case the amount of working capital

needed is less since it releases pressure by improving profitability and improving the
internal generation of funds.

15. Availability of Credit: The need for working capital in a firm will be less, if it avails liberal
credit facilities. Similarly, the availability of credit from banks also influences the working

capital needs of the fi rm. A firm enjoying bank credit facilities can secure funds to fi nance
its working capital requirement very easily, whenever it requires. It can therefore, perform
its business activities with less working capital than a fi rm without such credit facility.
The amount of working capital is also influenced by the inventory policies, depreciation policies,

management attitude and wages and government policies.

LOVELY PROFESSIONAL UNIVERSITY 139