Question

Explain the following as factors affecting the requirements of working capital:
(i)Nature of business
(ii)Scale of operations
(iii)Seasonal factors
(iv)Production cycle

Answer 1

Working capital refers to the investment in current assets that can be converted in cash or cash equivalent easily.

(i)Nature of business: An organisation that deals in services or trading will not require much of working capital . This is because such organisation involve small operating cycle and there is no processing done. In contrast to this, a manufacturing firm involves large operating cycle and the raw materials need to be converted into converted into finished goods before the final sale transaction take place. Thereby, such firms require large working capitals.

(ii)Scale of operations: If a firm operates on a large scale, the requirement of the working capital increases. This is because such firms would need to maintain high stock of inventory and debtors. In contrast to its, if the scale of operation is small, the requirement of the working capital will be less.

(iii)Seasonal factors: During the period of high sale, there is higher production,higher stock and more debtors.Thus, during this period the need to working capital increases.As against this, in seasons of low sale, there is less production and inventories.Thus,the working capital requirement reduces.

(iv)Production cycle: If a firm has a longer span of production cycle or there is a long term gap between the receipt of raw material and their conversion into finished goods, then there will be high requirement of working capital due to inventories and related expenses.On the other hand, if the production cycle is short, then the requirement of working capital will be less.