Question

Explain briefly any four factors that affect the working capital requirement of a company.

Answer 1

Working capital refers to current assets which help in day-to-day business operations. For example, cash, debtors and stock. Working capital has an impact on both liquidity and profitability of a business.

Four factors affecting the working capital requirement of a company

1) Type of Business: The nature of a business is one of the important determinants of working capital requirement. For instance, organisations dealing in services have shorter operating cycles, i.e. no processing is done in such organisations. Accordingly, they require low working capital. As against this, an organisation dealing in manufacturing would require large working capital. This is because it involves a large operating cycle, i.e. the raw materials first need to be transformed to finished goods before they are offered for sale.

2) A scale of Operations: Firms which operate on a larger scale require greater working capital than those which operate on a lower scale. This is because firms with the greater scale of operations are required to maintain the high stock of inventory and debtors. As against this, a business with a smaller scale of operation requires less working capital.

3) Fluctuations in Business Cycle: In various phases of the business cycle, the requirement of working capital is different. For instance, in the phase of a boom, both production and sales are higher. Accordingly, the requirement of working capital is also high. As against this, in the phase of depression, the demand is low, and so production and sale are low. Accordingly, there is less requirement of working capital.

4) Production Cycle: Production cycle refers to the time gap between receiving goods and their processing into final goods. Longer the production cycle for a firm, larger are the requirements of working capital and vice versa. This is because a longer production cycle would imply greater inventories and other related expenses, so greater requirement of working capital.