Working capital and Factors affecting the same
Working capital refers to an excess of current assets over current liabilities. It can be negative when current liabilities are greater than current assets. The networking capital indicates the liquidity position of the company. The positive net working capital implies a positive liquidity position whereas negative net working capital indicates a weak and poor liquidity position. Let’s discuss the factors affecting the working capital.
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Factors affecting the working capital
1. Nature of business
The basic nature of a business influences the amount of working capital required. A trading organization and service indicators usually need a smaller amount of working capital compared to a manufacturing organization. Therefore, manufacturing organizations required more raw materials, machinery, and more cost is involved in preparing goods.
2. Scale of operation
Firms that operate on a higher scale need to maintain more stocks, therefore, such firms require more working capital compared to the organization which operates on a lower scale.
3. Business Cycle
During the boom period market is flourishing that is, there is more demand, more production, more stock, more debtor which means more working capital. Whereas, during depression there is less demand, less stock, to be maintain so less working capital is required.
4. Seasonal factors
The company which is selling seasonal goods requires more working capital during the season as there is more demand and more stock has to be maintained whereas, during the off-season, demand is very low so less working capital is needed.
5. Production cycle and technology
If the production cycle is long then more working capital will be required, therefore, it will take a long time for converting raw material into finished goods whereas when the production cycle is small then less working capital is required.
Similarly, if the company is using a labor-intensive technique then more working capital is required because the company needs to maintain enough cash flow for making payment to labor, whereas if the company is using the capital intensive technique of production then less working capital is required because investment in machinery is fixed.
6. Credit Allowed
Credit policy refers to the average period for the collection of sale proceeds. If company is following a liberal credit policy then it will be required more working capital whereas if the company is following a strict or short-term credit policy, then it can manage with less working capital.
7. Credit availed
If suppliers of raw materials are giving long-term credit then the company can manage with less amount of working capital whereas if suppliers are giving only short-term credit then the company will require more working capital to make payments to creditors.
8. Operating efficiency
A firm having a high degree of operating efficiency requires less amount of working capital as compared to the firm having a low degree of efficiency which requires more working capital.
9. Availability of raw material
If raw materials are easily available and there is a ready supply of raw material then the firm requires less working capital as they need not maintain stock. Whereas if the supply of raw material is not enough then large working capital is required.
10. Growth prospects
If firms are planning to expand their business it will require more working capital as for expansion they need to increase production which requires more raw material etc.
11. Level of competition
If the market is competitive then the company will have to adopt a liberal credit policy to supply goods on time which means more working capital is required. In case there is no competition like monopoly then less work is required.
If there is an increase in price, then the price of raw materials and cost of labor will increase, thus more working capital is required. However, the effect of rising prices on working capital will be difficult for different businessmen.
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