OMTEX CLASSES: What is Working Capital? Factors affecting requirement of Working capital?

What is Working Capital? Factors affecting requirement of Working capital?



Meaning: -There is no universally accepted definition of working capital. Various financial experts used this tern in different ways. Some explain it in a narrow sense while some in a wide sense. In the narrow sense, it is the "difference between current assets and current liabilities".

Definition: -" The excess of current assets over current liabilities". (Defined by......Gerstenbergh)

Factors affecting requirement of Working Capital:
1.       Nature of business: -The working capital requirements are highly influenced by the nature of business

2.       Size of business: -The size of business also affects the requirement of working capital. Size of the firm maybe estimated in terms of scale of operation. A firm with large scale operation will require more working capital.

3.        Volume of cycle: -This is the most important factor affecting size of working capital. The volume of sale and the size of working capital are directly related with each other. If the volume of sales increases, there is an increase in amount of working capital.

4.        Production cycle: -The process of converting raw material into finished goods is called 'Production Cycle'. If the production cycle period is longer, the firm needs more amount of working capital. If the manufacturing cycle is short, it requires less working capital.

5.       Business cycle: -When there is upward-swing in economy, sales will increase. This will lead to increase in investment in stock. This act will require additional working capital. During recession(decline) period, sales will decline and consequently the need of working capital will also decrease.

6.       Terms of purchase and sale: -If credit terms of purchase are favourable and terms of sales are less liberal, then requirement of cash will be less. Thus working capital requirement will be reduced. A firm gets more time for payment to suppliers. A firm which enjoys more credit facilities needs less working capital.

7.       Credit control: -Credit control includes the factors such as volume of credit sales, the terms of credit sales, the collection policy, etc. if credit control policy is sound; it is possible for the company to improve its cash flow.

8.       Growth and expansion: -The working capital requirement of a firm will increase with growth of firm. The growth of firm is in terms of sales or even fixed assets. A growing company needs funds continuously to support large scale operation.


9.       Management ability: -The requirement of working capital is reduced if there is proper co-ordination in production and distribution of goods. A firm stocking on heavy inventory calls for higher level of working capital.