FACTORS AFFECTING WORKING CAPITAL The need of working capital is not always the same.

It varies from year to year or even month to month depending upon a number of factors. There are no set rules or formulae to determine working capital needs of the firm. Each factor has its own importance and the importance of factor changes for a firm over time. In order to determine the proper amount of working capital of a concern, the following factors should be considered carefully:Nature of business: The amount of working capital is basically related to the nature and volume of the business. In concerns where the cost of raw materials to be used in the manufacture of a product is very large in proportion to its total cost of manufacture, the requirements of working capital will be large. On the contrary, concerns having large investments in fixed assets require lesser amount of working capital. Size of the business unit: Size of the business unit is also a determining factor in estimating the total amount of working capital. The general principle in this regard is that the bigger the size, the larger will be the amount of working capital required since the larger business units are required to maintain larger inventories for the flow of the business. Seasonal Variations: Strong seasonal movements create special problems of working capital in controlling the financial swings. A great many companies have to carry out seasonal business such as sugar mills, oil mills or woollen mills, etc. and therefore they require larger amount of working capital in the season to purchase the raw materials in large quantities and utilize them throughout the year. Time Consumed in Manufacture: The average time taken in the process of manufacture is also an important factor in determining the amount of working capital. The longer the period of manufacture, the larger the inventory required. Though capital goods industries manage to minimise their investment in inventories or working capital by asking advances from the customers as work proceeds on their orders. Turnover of Circulating Capital: Turnover means the ratio of gross annual sales to average working assets. In simple words, it means the speed with which circulating capital completes its rounds or the number of times the amount invested in working assets have been converted into cash by sale of the finished goods and re-invested in working assets during a year. The faster the sales, the larger the turnover. Conversely, the greater the turnover, the larger the volume of business to be done with given working capital. Labour v/s Capital Intensive Industries: In labour intensive industries, larger working capital is required because of regular payment of heavy

wage bills and more time taken in completing the manufacturing process. The capital intensive industries require lesser amount of working capital because of the heavy investment in fixed assets and shorter period in manufacturing process. Need to Stockpile Raw Material and Finished Goods: In industries, where it is necessary to stockpile the raw materials and finished goods, it increases the amount of working capital tied up in stocks and stores. In certain lines of business where the materials are bulky and best purchased in large quantities such as cement, stockpiling is usual. Such concerns require larger working capital. Terms of Purchase and Sale: Terms (cash or credit) of purchase and sales also affect the amount of working capital. If a company purchases all goods in cash and sells its finished product on credit also naturally, it will require larger amount of working capital. On the contrary, a concern having credit facilities and allowing no credit to its customers, will require lesser amount of working capital. Terms and conditions of purchase and sale are generally governed by prevailing trade practices and by changing economic conditions. Conversion of Current Assets into Cash: The need of having cash in hand to meet the day-to-day requirements, e.g. payment of wages and salaries, rents, rates, etc. has an important bearing in deciding the adequate amount of working capital. The greater the cash requirements, the higher will be the need of working capital. Growth and Expansion: Growing concerns require more working capital than those which are static. It is logical to expect larger amount of working capital in a growing concern to meet its growing needs of funds for its expansion and/or diversification programmes though it varies with economic conditions and corporate practices. Business Cycle Fluctuations: Business cycles affect the requirement of working capital. At times, when the prices are going up and boom conditions prevail, the tendency is to pile up a large stock of materials and to maintain a large stock of finished goods with an expectation to earn more profits. The other type of business cycle, i.e. depression involves in locking up of a big amount in working capital as the inventories remain unsold and book debts uncollected. Profit Appropriation: Some firms enjoy dominant position in the market due to quality product or good marketing. On the other hand, a firm facing extremely tough competition may earn low margins of profits. A high net profit margin contributes towards working capital provided it is earned in cash. The working capital requirement will be estimated on how the cash available is used rightfully. The contribution towards working

capital is affected by the way in which profits are appropriated and therefore it is affected by taxation, depreciation, reserve policy, etc. Price Level Changes: The financial manager should also anticipate the effect of price level changes on working capital requirements of the firm. Generally, rising price levels will require higher amount of working capital since to maintain the same level of current assets, higher investment will be required. The effects of rising price levels will be different for different firms depending upon their price policies, nature of the product, ability to pass on the increase to the customer, etc. Dividend Policy: There is a well established relationship between dividend and working capital in companies where conservative dividend policy is followed. The changes in working capital position bring about an adjustment in the dividend policy. A shortage of cash may induce the management for reducing cash dividend. On the other hand, strong cash position may justify higher cash dividend. Other Factors: In addition to the above, there are a number of other factors which affect the requirement of working capital. Some of them are the production and distribution policies, absence of specialisation in the distribution of products, means of transportation and communication infrastructure, hazards and contingencies inherent in a particular business, etc.