What Is Working Capital ?
Working capital refers to the fund available in the business to meet
day-to-day expenses. It is essential to meet short term financial needs and
to operate business activities efficiently. Working capital is determined by
subtracting current liabilities from current assets of the company. Positive
or adequate working capital reduces financial risks and helps to increase
the profitability.
Determinants Of Working Capital Or Factors Affecting Working
Capital
Working capital of the firm are affected by the following factors:
1. Size And Nature Of Business
Large manufacturing firms require high amount of working capital than small
traders. On the other hand, production industries make greater investment in
working capital than trading organizations and service businesses. Service
enterprises can be operated with less amount of working capital. Therefore,
working capital requirement depends on the size and nature of
business.
2. Credit Period To Customers
If company allows longer credit period to its customers then it requires
more amount of working capital. But if it provides short credit period to
its clients, then it can invest less is working capital.
3. Credit Avail (Payment Terms)
If a firm can enjoy long credit period from supplier then less working
capital is required. But if there is short credit period on raw materials
and supplies, then more investment in working capital is needed.
4. Size Of Inventory
Size of inventory is another factor that influences the requirement of
working capital. Manufacturing industries require more working capital than
small scale business.
5. Impact Of Inflation Or Deflation
At the time of inflation a firm needs more working capital due to rise in
the price of raw materials, supplies and labor charges. On the contrary,
firm needs less working capital at the period of deflation because of
decrease in the price.
6. Seasonality/Seasonal Factor
Seasonality is another determinant of working capital. More working capital
is required during the production season because of high demand. But in lean
season, less working capital is enough because of low demand.
7. Dividend Policy Of The Company
Company's dividend policy is another factor that affects working capital.
If a firm distributes higher dividend and retains less profit, it may
negatively affect the working capital.
8. Creditworthiness Of The Company
It will be easy for the business to obtain credit or short term loan
because of good credit history. Otherwise, company needs to maintain more
working capital to meet short term requirements.
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9. Operational Efficiency Of The Firm
High degree of operational efficiency ensures optimum utilization of
resources and minimizes wastage that helps to minimize working capital
requirement. Conversely, poor operating efficiency increases the investment
in working capital.
10. Production Cycle
Long production cycle consumes more time and resources to produce products.
So, it requires more working capital than short production cycle.
11. Government Policy And Regulations
Government policies (tax policy, industrial policy etc.) and strict
regulations also determine the investment in working capital of the
firm.
