FACTORS DETERMINING WORKING CAPITAL REQUIREMENTS
Working Capital requirements depends upon various factors. There are no set of rules or
formula to determine the Working Capital needs of the business concern. The following
are the major factors which are determining the Working Capital requirements.
Nature of business: Working Capital of the business concerns largely depend
upon the nature of the business. If the business concerns follow rigid credit policy
and sell goods only for cash, they can maintain lesser amount of Working Capital.
A transport company maintains lesser amount of Working Capital while a
construction company maintains larger amount of Working Capital.
2. Production cycle: Amount of Working Capital depends upon the length of the
production cycle. If the production cycle length is small, they need to maintain
lesser amount of Working Capital. If it is not, they have to maintain large amount
of Working Capital.
3. Business cycle: Business fluctuations lead to cyclical and seasonal changes in the
business condition and it will affect the requirements of the Working Capital. In
the booming conditions, the Working Capital requirement is larger and in the
depression condition, requirement of Working Capital will reduce. Better business
results lead to increase the Working Capital requirements.
4. Production policy: It is also one of the factors which affects the Working Capital
requirement of the business concern. If the company maintains the continues
production policy, there is a need of regular Working Capital. If the production
policy of the company depends upon the situation or conditions, Working Capital
requirement will depend upon the conditions laid down by the company.
5. Credit policy: Credit policy of sales and purchase also affect the Working Capital
requirements of the business concern. If the company maintains liberal credit
policy to collect the payments from its customers, they have to maintain more
Working Capital. If the company pays the dues on the last date it will create the
cash maintenance in hand and bank.
6. Growth and expansion: During the growth and expansion of the business
concern, Working Capital requirements are higher, because it needs some additional
Working Capital and incurs some extra expenses at the initial stages.
7. Availability of raw materials: Major part of the Working Capital requirements
are largely depend on the availability of raw materials. Raw materials are the basic
components of the production process. If the raw material is not readily available,
it leads to production stoppage. So, the concern must maintain adequate raw
material; for that purpose, they have to spend some amount of Working Capital.
8. Earning capacity: If the business concern consists of high level of earning
capacity, they can generate more Working Capital, with the help of cash from
operation. Earning capacity is also one of the factors which determines the
Working Capital requirements of the business concern.
COMPUTATION (OR ESTIMATION) OF WORKING CAPITAL
Working Capital requirement depends upon number of factors, which are already discussed
in the previous parts. Now the discussion is on how to calculate the Working Capital needs
of the business concern. It may also depend upon various factors but some of the common
methods are used to estimate the Working Capital.
A. Estimation of components of working capital method
Working capital consists of various current assets and current liabilities. Hence,
we have to estimate how much current assets as inventories required and how
much cash required to meet the short term obligations.
Finance Manager first estimates the assets and required Working Capital for a
B. Percent of sales method
Based on the past experience between Sales and Working Capital requirements, a
ratio can be determined for estimating the Working Capital requirement in future.
It is the simple and tradition method to estimate the Working Capital requirements.
Under this method, first we have to find out the sales to Working Capital ratio and
based on that we have to estimate Working Capital requirements. This method also
expresses the relationship between the Sales and Working Capital.
C. Operating cycle
Working Capital requirements depend upon the operating cycle of the business.
The operating cycle begins with the acquisition of raw material and ends with
the collection of receivables.