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9 Determinants of Working Capital of a Company| Financial Management

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❶Depending upon the kind of items manufactured, a company is able to offset the effect off- seasonal fluctuations upon working capital by adjusting its production schedules. A business unit, making purchases on credit basis and selling its finished products on cash basis, will require lower amount of working capital, on the contrary, a concern having no credit facilities and at the same time forced to grant credit to its customers may find itself in a tight position.

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To give an example, a baker requires one night time to bake his daily quota of bread. Between these two cases may fall other business concerns with varying periods of manufacture requiring different amounts of working capital. Generally, the size of the company has a direct relation with the working capital needs.

Big concerns have to keep higher working capital for investment in current assets and for paying current liabilities. Where the cost of raw materials to be used in manufacturing of a product is very large in proportion to the total cost and its final value, working capital required will also be more.

That is why, in a cotton textile mill or in a sugar mill, huge funds are required for this purpose. A building contractor also needs huge working capital for this reason.

If the importance of materials is less, as for example in an oxygen company, the needs of working capital will be naturally not more. In labour intensive industries, larger working capital will be required than in the highly mechanized ones. The latter will have a large proportion of fixed capital. It may be remembered, however, that to some extent the decision to use manual labour or machinery lies with the management.

Therefore, it is possible in most cases to reduce the requirements of working capital and increase investments in fixed assets and vice versa. The manufacturing concerns generally have to carry stocks of raw materials and other stores and also finished goods. The larger the stocks whether of raw materials or finished goods more will be the needs of working capital.

In certain lines of business, e. Similarly, in public utilities, which must have adequate supplies of coal to assure regular service, stock piling of coal is necessary. In seasonal industries finished goods stocks have to be stored during off seasons. All these require large working capital. Turnover means the speed with which the working capital is recovered by the sale of goods. In certain businesses, sales are made quickly and the stocks are soon exhausted and new purchases have to be made.

In this manner, a small amount of money invested in stocks will result in sales of much larger amount. Considering the volume of sales, the amount of working capital requirements will be rather small in such type of business.

There are other businesses where sales are made irregularly. For example, in case of jewellers, a costly jewellery may remain locked up in the show-window for a long period before it catches the fancy of a rich lady.

In such cases, large sums of money have to be kept invested in stocks. But a baker or a news-hawker may be able to dispose of his stocks quickly, and may, therefore, need much smaller amounts by way of working capital. A company purchasing all raw-materials for cash and selling on credit will be requiring more amount of working capital. Contrary to this, if the enterprise is in a position to buy on credit and sell it for cash, it will need less amount of working capital.

Determinants of Working Capital. The level of working capital is influenced by many factors. Nature of Business This is one of the main factors. Usually in trading businesses the working capital needs are higher as most of their investment is concentrated in stock or inventory. Manufacturing businesses also need a good amount of working capital to meet their production requirements. Whereas, those companies that sell services and not goods, on a cash basis require least working capital because there is no requirement on their part to maintain heavy inventories.

Size of business is another influencing factor. As size increases, the working capital requirement is also more and vice versa. Credit terms greatly influence working capital needs. Prevailing trade practices and changing economic condition do generally exert greater influence on the credit policy of concern. A liberal credit policy if adopted more trade debtors would result and when the same is tightened, size of debtors gets slim. Credit periods also influence the size and composition of working capital.

When longer credit period is allowed to debtors as against the one extended to the firm by its creditors, more working capital is needed and vice versa. Collection policy is another influencing factor. A stringent collection policy might not only deter away some credit customers, but also force the existing customers to be prompt in settling dues resulting in lower level of working capital. The opposite holds well with a liberal collection policy.

Collection procedure also influences the working capital needs. A decentralized collection of dues from customers and centralized payments to suppliers shall reduce the size of working capital. Centralized collections and centralized payments would lead to moderate level of working capital.

But with centralized collections and decentralized payments, the working capital need would be the highest. Agriculture and food processing and preservation industries have a seasonal production. During seasons, when production activities are in their peak, working capital need is high. This also affects the size of working capital.

Industries that use raw materials which are available during seasons only, have to buy and stock those raw materials. They cannot afford to buy these items in a phased way, since either supplies would get reduced or prices would be higher. Also, from the point of view of quality of raw materials, it pays to buy in bulk during the seasons.

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Some of the most determinants of working capital are: 1. Nature of business 2. Length of period of manufacture 3. Volume of business 4. The proportion of the cost of raw materials to total cost 5. Use of Manual Labour or Mechanisation 6. Need to keep large stocks of raw materials of finished goods 7.

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Some of the major determinants of working capital are discussed below: A company, as a general policy, wants to hold in balance as small a quantity of working capital as possible so long as undue solvency risks are not imposed on it. This is a logical approach indicating that working capital is a.

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In analyzing the determinants of working capital management, Chiou and Cheng (), found that there is an inverse relationship between capital structure of the firm and the two measures of liquidity: net liquid balance and working capital ratio. The determinants of working capital are items that have a direct impact on the amount invested in current assets and current liabilities. Managers like to keep a close watch over these factors, since working capital can absorb a large part of the funding that an organization has at its disposal.

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capital and short-term financing are referred to as working capital management (Nimalathason, ). It is the regulation, adjustment and control of the balance of current assets and current. Please do send us a request for Determinants of Working Capital tutoring and experience the quality yourself. Other topics under Working Capital Management: Aim of Working Capital Management.