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'S' Ltd. is manufacturing steel at its plant in India. It is enjoying a buoyant demand for its products as economic growth is at about 7-8% and the demand for steel is growing. It is planning to set-up a new steel plant to capitalise on the increased demand. It is estimated that it will require about Rs 5000 crores to set-up and about Rs 500 crores of working capital to start the new plant.

Keeping in mind that it is a highly capital intensive sector, what factors will affect the fixed and working capital? Give reasons concerning both in support of your answer.


Solution

The working and fixed capital requirement of S Ltd will be high due to the following reasons:

(i) The business is capital intensive, and the scale of operation is large.

(ii) Heavy investments are required for building up the production base and for a technological upgrade. 

(iii) In the case of the steel industry, the primary inputs are iron ore and coal. The ratio of cost of raw material to total cost is very high. Hence, the need for working capital will be higher.

(iv) The longer the operating cycle, the larger is the amount of working capital required as the funds get locked up in the production process for an extended period.

(v) Terms of credit for buying and selling goods, discount allowed by suppliers to the customers also determine the quantum of working capital.

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