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Factors Affecting Working Capital

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May 9th, 2011
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The working capital requirements of a business depends upon a number of ‘factors which in brief are as under:-

(1) Nature of the business. The working capital requirements of an enterprise basically depends upon the nature of its business and operating cycle of the business. A trading concern, for instance, requires large amount of working capital for investment in stocks, receivables and cash etc. It requires less investments in fixed assets. A business where the proportion of cost of raw material to be consumed to total cost of production is high, the amount of working capital required is large, shipbuilding for instance.

(2) Size of the business. The amount of working capital needed depends upon the scale of operation of the business. The larger the size of the business unit, generally the larger is the requirement of working capital and vice versa.

(3) Length of period of manufacture. If the goods are tied up for a longer period of time in. the production process such as ship building, heavy armaments, aeroplanes etc., it requires a large amount of working capital to meet the manufacturing expenses until the payment is received for the finished products. In case of short manufacturing process of a commodity such as cloth, shoes etc. the capital is not tied for a longer period and as such the amount of circulating capital will be small compared to the ship building industry.

(4) Methods of purchase and sale of commodities. If a business is able to purchase the raw material and other allied products on credit and is able to sell the manufactured goods on cash it will need less amount of working capital In case the raw material is purchased on cash and goods are sold on credit the amount of required working capital would be large.

Working Capital Cycle

(5) Converting working assets into cash. If the assets of a business have liquidity i.e. they are readily saleable for cash then less amount will be set aside for working capital. In case the assets are not quickly saleable for cash then a greater amount f working capital will be required by it.

(6) Seasonal variation in business. There are certain industries which purchase raw material in the production season such as cotton, rubber and consume the material in the off season for the manufacturing of products. These industries require large amount of working capital to purchase the raw material in a production season and pay the wage costs in the off season.

(7) Risk in business. A business like the oil exploration involves great risk. The business may or may not be able to find out the oil by digging of wells: The business needs huge amount of working capital in such risky enterprises.

(8) Size of labour force. If the size of labour force employed in the manufacture of a product is fairly, large, (labour intensive), the business will need a greater amount of working capital. In capital intensive industries lesser amount of working capital is required.

(9) Price level changes. If the prices are rising very rapidly in the country the business will require greater amount of working capital to maintain the same current assets and vice versa.

(10) Rate of turnover. If in a business, the sale is faster i.e., a business has rapid turn over then the amount of working capital required may be small as cash is realized from sales. A business where the rate of turn over is slow there is more requirement of working capital in that business.

(11) State of business activity. When the business is prosperous it needs more working capital for increasing the volume of business. On the contrary when the business is slack and sales decline then less amount of working capital is required.

(12) Business policy. If a business sets aside funds at the end of each year for the depreciation, payment of loans and ploughing back of profits in the business, it requires less amount of working capital. On the other hand, .a business which does not build its own internal resources, needs larger amount of working capital to meet the day today expenses of the business and other unexpected expenses.

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