Factors Affecting Working Capital Requirement
A business has to make investment in current assets for the day to day operations
. Liquid/current assets contribute less to the profits than fixed assets. Examples are as under,
1. Cash in hand/at bank
2. Marketable securities
3. Bills receivables
4. Debtors
5. Finished goods inventory/stock
6. Work in Progress
7. Raw materials
8. Prepaid expenses
These assets are expected to get converted into cash or cash equivalent in less than an year.
Current assets are usually financed through short term sources like current liabilities. The net working capital is defined as the excess of current assets over current liabilities.
The factors affecting Current assets are the following:
1.Nature of business: A trading organization requires larger working capital than a manufacturing one. Thus, the basic nature of a business influences the requirement of working capital.
2.Scale of operation: Organization which operates on a large scale requires more working capital than those which operate on a small scale.
3.Business Cycle: The phase of market, depression or boom affects the requirement of working capital.
4.Seasonal Factors: Seasonal growth or slowdown affects the need of working capital in a firm.
5.Production Cycle: The time period between receipt of raw material and their conversion into finished goods is called production cycle. Firms that have al longer production cycle require a larger working capital.
6.Credit Allowed: The extent of credit allowed by the company to its clients affects the requirement of working capital. A liberal credit policy calls for more working capital since the number of debtors increases.
7.Credit Availed: The amount of credit a firm avails from its suppliers also has an affect over the working capital. More the credit availed, lesser is the working capital needed.
8.Operating efficiency: A firms operating efficiency in terms of debtors turnover, inventory turnover etc. lowers down the requirement of working capital.
9.Availability of raw material: The availability of raw material in terms of lead time, continuity and quantity affects the need of working capital.
10.Growth Prospects: It shares a direct relation with working capital. Higher the growth rate higher would be the working capital required.
11.Level of competition: higher level of competition may necessitate larger stocks of finished goods to meet urgent demands/orders from customers. This increases the working capital requirement. Competition may also force a firm to extend liberal credit terms.
12.Inflation: working capital requirement becomes higher with a high inflation rate because the cost of maintaining production and sales increases.
So, I hope the points have been of use to all those who were a little dicey about deciding about deciding the best amount if working capital for their business.
People looking to buy a going concern business for sale have to make certain preparations before getting started. So, they can take help from the factors listed above to accurately calculate the need of working capital for their business.
You can take help of your manager to know the trend of the market and take action accordingly. Good luck people!
by: pauldarreman
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