Question

Discuss about working capital? How is it calculated? Discuss five important determinants of working capital requirements.

Answer 1

Unless otherwise specified is the net working capital. Net working capital is the excess of current assets over current liabilities. Thus, Net Working Capital = Current Assets - Current Liabilities or

NWC = CA - CL

Factors affecting working capital:

• Nature of Business
  

The basic nature of a business influences the amount of working capital. A trading organisation and a service industry firm usually need a smaller amount of working capital as compared to a manufacturing organisation.

• Scale of Operations
  

Organisations which operate on a large scale, their quantum of inventory and debtors required is generally high. Such organisations, therefore, require large amount of working capital as compared to the organisations which operate on a lower scale.

• Business Cycle
  

Different phases of business cycles affect the requirement of working capital by a firm. In case of a boom, the sales, as well as production, are likely to be larger and, therefore, larger amount of working capital is required. As against this, the requirement for working capital will be lower during the period of depression, since the sales as well as production will be less.

• Seasonal Factors
  

Some of the businesses have seasonal operations. During peak season, larger amount of working capital is required because of higher level of activity.

As against this, the level of activity, as well as the requirement for working capital, will be lower during the lean season.

• Production Cycle/Operating Cycle
  

Production cycle is the time span between the receipt of raw material and their conversion into finished goods. 4

Some businesses have a longer production cycle while some have a shorter one. Duration and the length of production cycle affect the amount of funds required for raw materials and expenses.

• Credit Allowed '
  

Different firms allow different credit terms to their customers. These depend upon the level of competition that a firm faces, as well as the credit worthiness of their client.

A liberal credit policy results in higher amount of debtors, increasing the requirement of working capital.

• Credit Availed
  

Just as a firm allows credit to its customers, it also may get credit from its suppliers. To the extent, it avails the credit on purchase, the working capital requirement is reduced.

• Availability of Raw Materials
  

If the raw materials are easily and readily available, lower stocks will have to be maintained. Whereas,

when the raw materials are scarce or not readily available, higher stock levels have to maintained, thus increasing the need for working capital requirement.

• Time Lag
  

It is also known as lead time and is an important factor as to how much working capital is required. Time lag is the time taken between the placement of order and actual receipt of material.

If the time lag is more, more working capital will be required, as larger amount of materials will have to be stored.