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Financial Management : Principles and Practice

availabili"ty ofjaw materials and level of profit. The following factors affect working capital:
, ,
1. Nature of Business
The nature of business activity determines the amount of working capital requirement. A business
, " that is'conducted mainly through cash sales or a business providing services will require minimum
working capital. Continuous investment is not required in inventories as, such firms have a
surplus of cash. A company doing bread business will not require too much inventory as its
I) goods are sold on cash'. Manufacturing industries have different types of working capital
a
'. .requirements. Manufacturingfirms that have long operating cycle require a large volume of
" working capitaL.,' ,~~," " -
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'B~~le.~~SCycle, :>.~,:"'" . '<' '-
i" •.' ~ •. : 1.'
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, ',:.,' " ~,Working capital requirement depends on the' business fluctuations. An upward level of economic
activity will increase business activities. Although the firm makes higher profits,- the need for
:working capital increases. Business activities will expand and the demand forrequirement of
. i!8sh as well gs inventories will increase. When an economy faces recession there will be a fall
in business activities and subsequently the requirement of working capital will be reduced .
•. .A

3., ,.Se'asonal Fluctuations ,


Finns that have wide fluctuations during different seasons will require heavy amounts of working
capital in -the seasons when demand of the product is high, Consequently there will be a
requirement of a higher ~Jume of inventories. In wool industries in Ind ia, there is a seasonal
requirement of woolen products is winter only for approximately 3 months in a year. During
, these months the requirements of working capital in terms of inventories and cash will be
higher than in other months when business activity is low. Companies that have business
throughout
.
the year will have to maintain a~'
even amount of working capital .throughout
~
the .'

year.
4. Credit Policy ,, '
The credit policy of a company depends on its purchases and sales. The credit policy of the
firm its customers as well as the purchasers/ suppliers of its firm affect its working capital
requirements. In a liberal credit policy, debtors will be high and the working capital to be maintained
will also be required in a greater volume because receivables will be for a longer period oftime.
If the firm has a liberal credit policy from its suppliers, the requirement of working capital will
be less as there will be no pressure for making payments quickly. Firms that procure materials
on credit but sell their own products in cash will require a low level ofworking capital. If the
firm buys on cash and sells its products on credit volume of working capital required by it would
be higher.
5. Availability of Raw Materials
Thesupply of raw materials has an effect on the working capital of a,firm. The time period of
'receiving inventory de'cides the level of working capital with the firm. If the supply of raw
materials is received without any delay, the level of inventories maintained by a firm will be low,
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Working Capital Management 9.13


. . ,I .....
if the tune period taken to procure materials is uncertain the firm has to maintain a high level of
inventory. ~ "~i',' ~,

6. Level of Profit
The profits of a firm depend on its quality and nature of product. Ifa product is a monopoly item
then its sales will be high and the profit margins will be good. The firm should make a policy to
meet its expenses and cover its costs, and then its requirements of working c,~pita~ will be low,
Firms with low levels of profits will require a higher amount of cash for their business operations.
The level of profit in products that are competitive, wit!l a good sells vohjni~ 'Y>'i11 have to
estimate the requirement's of their working capital according to their cash c'y~te~~:Whatever is
the level of profit it iSla firm should be able to meet its, ca~h'requi~em~9!~Jiclru'Oning the
.
b USIIlCSS. . " ~'" '. ·"r')
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Hence working capital will depend on sales, receivable, credit and debit policies besides a high
or low level of profit. Working capital requirements , depend on many . fac,torfb~t.it.is
':' .•... ,.1••.••
important
to manage the working capital efficiently. The firm.should have a good policy ,
to'continuously
'''.,.;.1

review its costs. A trade off between risk and profita.~~~:\~!??S~~;: '.,'

~:'hi~f~C~~(~~I:~7:s~~
I~;)~:t
Cash a! includes ne r cash
of eh
assets s*h as ma
., drafts. ~e and depoSi~~nd '~urrency
ketable securiti sand time deposits held in
differ '/1 banks. It is quired for ma aging ev ry day transac ons in a,tl organization, e
motives of handling c sh in a firm / c mpany is mainly for tran actions but is also useful or
precaut onary and spc ulative motive . Cash ma agement sync. ronizes
.
cash receipt~nd
4. .::1 "
ash
I .
payrnet ts. . ,,~,'i',?:'~,
. ." ,;.' '; :tl;r'!'t-

The ob cctive of cash ianagernent is 0 balanc its receipts and payments and also to min mize
idle fUI ds with the fin . Funds have t be main ined for meeti g the payment'scheduie time
• •. • ..•...
- .. ", .! :-'1 •• ' r ~•.; 1,\; ~
andfo keeping minii urn cash balan e with t e firm.Ir-, \'. "·~·\,nJ.F...r-'·.i.:;';':}!:\:·J'-s':;;
" ~,'-. ..-'~ tt~·~ . ~~ ~', ",::',:! ~~-l'~'i~
.•.;~~~ ,'.~;
i~\:
9.2.1 Factors Det rmining Cash Rcqui ements .P'~~::.. '0:)
I - ••••• .• .a
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,. of :. .,;'
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":" . * . "J.. J'r';r •.•._::.:.- ':
The ctors that am ct the cash bala ces ar . (i):Cash inflo s and outflow.s~(ii)Co t of cash
bala ce (iii) Cash c cle and (iv) Sho costs .;~." ':'1 :~. ;,f' i
1:
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~ .. I , '''-: .,.01; r' t ). !:
, ;": f • (, • ~, '•.••

ash Inflows a d Outf1ows~; ,:t', ~.' ,.~',.


Cas flows in the I rn are due to tra sacti s. The timing of nflows andoutflcw of cash is not
ma ched.A C~S~l a ance is require to m . e payments' oft~ fi.i~~s schedule ;.JR~~.technique
fo synchroniz 19 ash flows of n firm IS to forecast the c sh needs and: prepare a cash
bu get (0 ion a basis for keeping a re erve of cash available as and wh payments arise.
,,\\. 'l-.
2. Cost of ash Balance ~ .. 't. ,~.t.=::t"': . ~'f •

C h balanc in~lIrs a cost of capital~timum " .


1
flim becallsc he:
if cash bulan ~ IS low then th.e firm will face cost of, ',I uni~,lost. If i~has a hjgh balance .'
:
there will b Idle resources In the firm. Cash ras a cost 'of g.arrying!.'and the, costvof not ,i
r t, •• I"'~,!, •

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