The working capital needs of a firm are influenced by numerous factors.

The important
ones are

i) Nature of business: The working capital requirement of a firm is closely related

to the nature of business . A service firm , like electricity undertaking or a transport
corporation which has a short operating cycle and which sells predominantly on cash
basis , has a modest working capital requirement . On the other hand , manufacturing
concern like a machine tools unit , which has a long operating cycle and which sells
largely on credit has a very substantial working capital requirement .

ii) Seasonality of Operation : Firms which have marked seasonality in there

operations usually have highly fluctuating working capital requirement. For example ,
consider a firm manufacturing air conditioners . The sale of air conditioners reaches the
peak during summer months and drops sharply during winter season . The working
capital need of such a firm is likely to increase considerably in summer months and
decrease significantly during winter period . On the other hand , a firm manufacturing
consumer goods like soaps , oil , tooth pastes etc. which have fairly even sale round the
year , tends to have a stable working capital need .

iii) Production Policy: A firm marked by pronounced seasonal fluctuation in its

sale may pursue a production policy which may reduce the sharp variations in working
capital requirements. For example a manufacturer of air conditioners may maintain
steady production through out the year rather than intensify the production activity during
the peak business season. Such decision may dampen the fluctuations in working capital
requirements.

iv) Market Conditions: When competition is keen, larger inventory of finished

goods is required to promptly serve the customers who may not be inclined to wait
because other manufacturers are ready to meet their needs. Further generous credit terms
may have to be offered to attract customers in highly competitive market . Thus , working
capital needs tend to be high because of greater investment in finished goods inventory
and accounts receivable .

If the market is strong and competition is weak , a firm can manage with smaller
inventory of finished goods because customers can be served with delay . Further in such
situation the firm can insist on cash payment and avoid lock up of funds in accounts
receivables – it can even ask for advance payment , partial or total .

v) Conditions of Supply: The inventory of raw material, spares and stores depends
on the conditions of supply. If supply is prompt and adequate, the firm can manage with
small inventories. However if the supply is unpredictable and scant then the firm , to
ensure continuity of production , would have to acquire stocks as and when they are
available and carry large inventories on an average . A similar policy may have to be
followed when the raw material is available only seasonally and production operations
are carried out round the year.
Tags: accounts receivable, capital requirement, cash basis, Conditions of Supply, Factors
Affecting Working Capital, Finished Goods, highly fluctuating working capital
requirement, long operating cycle, manufacturing concern, Market Conditions, Nature of
business, operating cycle, Production Policy, Seasonality of Operation

Factors Affecting working Capital needs

February 7, 2009

in Finance Management

A firm should have neither low nor high working capital. Low working capital involves
more risk and more returns, high working capital involves less risk and less returns. Risk
here refers to technical insolvency while returns refer to increased profits/earnings. The
amount of working capital is determined by a wide variety of factors.

1. Nature of business
2. Seasonality of operations
3. Production cycle
4. Production policy
5. Credit Policy
6. Market conditions
7. Conditions of supply

Nature of Business: The working capital requirement of a firm depends on the nature of
the business. For example, a firm involved in sale of services rather than manufacturing
or a firm is allowing only cash sales. In the first instance, no investment is required in
either raw materials or WIP or finished goods, while in the second instance there exists
no receivables as there is immediate realization of cash. Hence the requirement of
working capital will be lower.

Seasonality of Operations:

If the product of the firm has a seasonal demand like refrigerators, the firms need high
working capital in the periods of summer, as the demand for the refrigerators is more and
the firm needs low working capital in the periods of winter, as the demand for the product
is low.

Production Cycle:

The term production cycle refers to the time involved in the manufacture of goods. It
covers the time span between the procurement of the raw materials and the completion of
the manufacturing process leading to the production of goods. As funds are necessarily
tied up during the production cycle, the production cycle has a bearing on the quantum of
working capital. The longer the time span of production cycle, the larger will be the funds
tied up and therefore the larger the working capital needed and vice versa.

Production Policy:

The quantum of working capital is also determined by production policy. In case of the
firms having seasonal demand of the products like refrigerators, air coolers etc., The
production policy of the firm determines the amount of working capital requirement. If
the firm has production policy to carry production at a steady level to meet the peak
demand, this will result in a large accumulation of finished goods (inventories) during the
off-seasons and the abrupt sale during the peak season. The progressive accumulation of
finished goods will naturally require an increasing amount of working capital. If the firm
has production policy to produce only when there is a demand then the firm needs low
working capital during the slack season and high working capital during season.

Credit Policy:

The level of the working capital is also determined by the credit policy, as the firm’s
credit policy determines the amount of receivables. If the firm has a liberal credit policy,
then the firm needs high working capital and the firm needs low working capital if the
company’s credit policy does not allow it to extend credit to the buyers.

Market Conditions:

The working capital requirements are also determined by the market conditions. In case
of the high degree of competition prevailing in the market the firm has to maintain larger
inventories as customers are not inclined to wait for the product. This needs higher
working capital requirements. If there is good demand for the product and the
competition is weak, a firm can manage with smaller inventory of finished goods, as
customers can wait for the product if it is not available in the market. Thus, a firm can
manage with low inventory and will need low working capital requirements.

Conditions of Supply:

The availability of raw materials and spares also determine the level of working capital.
If there is ready availability of raw materials and spares, a firm can maintain minimum
inventory and need less working capital. If the supply of raw materials is unpredictable,
then the firm has to acquire stocks as and when they are available for ensuring continuous
production. Thus, the firm needs to maintain larger inventory average and needs larger
requirement of working capital.
–

[Abstract] an enterprise to maintain the normal functioning of the need to have an

appropriate amount of working capital, working capital for the production and marketing
activities in the enterprise is an important position in the enterprise profit goals will have
a major impact on working capital management is an enterprise financial management, an
important component, it should strengthen the working capital analysis.
[Key words] the risk of working capital profitability, solvency

Working capital of enterprises in production and management of funds used in the

process of working, but also can be understood as the process of production and business
enterprises in the use of net current assets. In quantity is equal to total current assets
minus total liabilities to the balance, is an integral part of liquid assets. Therefore,
working capital is characterized by the characteristics of liquid assets, namely, a short
payback period; with mobility; various forms of co-existence and the quantity of
volatility.
In the current assets, current liabilities from the part of the right to demand due to the
short-term constraints, and thus companies can not freely used in a relatively short period
of time. On the contrary, the current assets less current liabilities, companies can be free
to use a longer period. Because this part of the net current assets from long-term
financing raised in this way, and its debt to demand the right to time-pressure small.
Working capital is current assets and current liabilities is not only the difference
between the two, and its scale by the enterprises for the production and marketing of the
impact, while restricting the scale of production and operation of enterprises. Therefore,
working capital management can not simply consider the current assets and current
liabilities of the difference, while the need for the movement of funds from the enterprise
system to grasp the whole process.
Working capital is current assets an integral part of enterprise short-term solvency of
the important symbol. In general, the greater the amount of working capital, corporate
short-term liquidity, the stronger, and vice versa smaller. Therefore, increasing the size of
working capital, is to reduce the risk of an important guarantee for corporate debt.
However, the size of the increase in working capital will inevitably require the use of the
long-term financing companies to raise more funds for long-term occupation in the
current assets, but the long-term means of financing the cost of funds raised by large, will
affect the profitability of the enterprises, the long run, the final because profitability is
low, affecting liquidity, while the financial risk to the enterprise. On the contrary, small-
scale working capital, corporate financial risk is high and the profitability of big business.
Meanwhile, the working capital structure is different, will also affect corporate liquidity
and profitability. Therefore, to determine the size of working capital for the management
of working capital must be profitability, financial risk trade-off between the two. Can be
seen to be on working capital management, must be four elements of:
1, the financial risk
In theory, as long as the current assets over current liabilities, companies will have a
short-term solvency. Therefore, enterprises theoretical value of the minimum operating
capital to 0. But this must be based on the number of liquid assets, cash flows and the
maturity structure of liabilities to repay the same quantity and the maturity structure of
the premise of fully fit, otherwise, companies may form due to the risk of inability to pay.
Theoretically speaking, the financial risk in the enterprise there can be long-lived assets
to cash, to repay maturing debt. However, in practice, in order to maintain the normal
production and business operations, generally will not use long-term assets to pay current
liabilities. Furthermore, since the number of liquid assets realizable of great uncertainty,
mainly accounts receivable bad debts and stock commodity price-cutting possibility
exists, therefore the number of liquid assets of enterprises must be greater than current
liabilities, that is, working capital The number must be greater than 0. At the same time,
due to various types of liquid assets realizable realization rate and the number of
different, the net working capital as current assets of the structure is different, its
solvency is different, therefore, the attitude of business-to-financial risk is different from
the structure of working capital requirements are also different.
Second, profitability
If the business simply to consider the working capital to pay its debts to determine the
size and structure, is bound to restrain itself flexible, mobile use of working capital,
affecting the level of corporate earnings. Because of an enterprise solvency and
profitability of the results of each other, so if a long-term low level of corporate earnings
will eventually undermine its own solvency, and thus bring to the enterprise's own
financial risk. Profitability of the business is subject to income and the cost of two
factors, corporate size and structure of working capital are different levels of revenues
and costs are also different. If a company the size of working capital is too large, it will
increase the working capital in the non-profit scale and proportion of liquid assets, the
relative reduction of the enterprise's income, while increasing the cost of capital and
opportunity cost. Conversely, companies should be based on their own profit goals, to
determine the size and structure of working capital.
3, flexible
Flexibility in financial management due to the important role of, and therefore
working capital management to consider the possibility of self-transformation so that
when necessary, adjust the working capital structure. Practice management, flexible
working capital will affect the size, if the existing working capital flexibility to bad, but
also the need for working capital structure adjustment, the face of this situation
companies have two options: The first option is to sacrifice the credit and benefits , will
be flexible in working capital less forced to change their shape; The second option is to
increase the flexibility of working capital size, for the preparation of short-term debt
payments and financial adjustments, which will increase their cost of capital, reduce
benefits, maintenance company's existing credit. Reposted elsewhere in the paper for free
download http://www.hi138.com

4, operating capacity
Operation is the operation, operational capability means business operational
capability. Narrow understanding is that the speed of business operations, mainly for
asset management and use efficiency, namely, the velocity of turnover of assets in the
financial analysis commonly used to represent the turnover of assets, mainly including
mobile asset turnover, fixed asset turnover, and total asset turnover ratio index.
Corporate profitability and solvency are related to the enterprise survival and
development of major problems. There is no profitable business can develop even to
survive without solvent companies can not be guaranteed. So the fight for greater
profitability and adequate working capital management, solvency is an important content,
but also financial management, and the whole business management major goal. Working
capital to maintain a certain degree of flexibility is the basis for the implementation of
financial policies, if, working capital to maintain a rigid, inflexible, financial
management can not perform many of the major measures, financial policy can not be
implemented, financial management objectives could not be achieved. If you maintain a
working capital from the ultimate flexibility in terms of the objectives is to improve the
profitability of the business and maintain adequate liquidity, and operational capacity of
enterprise sales, production and procurement capability and capacity to the degree of
coordination of three combined. Therefore, the operational capacity is not corporate
financial management capacity, but production and operation activities. But if not for the
three capacity or the ability of these three uncoordinated, naturally less corporate
financial management. Therefore, to maintain a certain degree of flexibility in working
capital and greater operational capability is the basis for the implementation of financial
management.
The size of working capital is subject to corporate financial risk, profitability,
operational capacity and financial flexibility to be. If you consider lowering the corporate
financial risks, the size of working capital, the higher the better; If you consider
increasing the profitability of the business factors, the smaller the size of working capital
as possible; if it considers necessary to adjust the capital structure, maintain adequate
capital elastic, flexible working capital for larger the better. Reposted elsewhere in the
paper for free download http://www.hi138.com