What is working capital? How is it calculated? Discuss five important determinants of working capital requirement.
What is working capital? How is it calculated? Discuss five important determinants of working capital requirement.
Calculation of working capital: Working capital, 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
The main factors affecting the working capital requirements are given below:
(i) Nature of Business: A trading organisation and a service industry firm usually needs a smaller amount of working capital as compared to a manufacturing organisation.
(ii) Scale of Operations of Organisations: These are those which operate on a large scale; their quantum of inventory and debtors required are generally high. Such organisations, therefore, require a large amount of working capital as compared to the organisations which operate on a lower scale.
(iii) 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, a 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.
(iv) Seasonal Factors: Some of the businesses have seasonal operations. During peak season, the larger amount of working capital is required because of the 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.
(v) Production Cycle/Operating Cycle: Production cycle is the period between the receipt of raw materials and their conversion into finished goods. Some businesses have a longer production cycle while some have a shorter one. Duration and the length of the production cycle affect the amount of funds required for raw materials and expenses.
(vi) 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 creditworthiness of their clientele. A liberal credit policy results in a higher amount of debtors, increasing the requirement of working capital.
(vii) 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 a purchase, the working capital requirement is reduced.
(viii) Availability of Raw Materials: If the raw materials are easily and readily available, lower stocks will have to be maintained. On the other hand, when the raw materials are scarce or not readily available, higher stock levels have to be maintained, thus increasing the need for a working capital requirement.
(ix) Time Lag: It is also known as lead time and is an important factor when deciding how much working capital is required. The 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.
Calculation of working capital: Working capital, 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
The main factors affecting the working capital requirements are given below:
(i) Nature of Business: A trading organisation and a service industry firm usually needs a smaller amount of working capital as compared to a manufacturing organisation.
(ii) Scale of Operations of Organisations: These are those which operate on a large scale; their quantum of inventory and debtors required are generally high. Such organisations, therefore, require a large amount of working capital as compared to the organisations which operate on a lower scale.
(iii) 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, a 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.
(iv) Seasonal Factors: Some of the businesses have seasonal operations. During peak season, the larger amount of working capital is required because of the 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.
(v) Production Cycle/Operating Cycle: Production cycle is the period between the receipt of raw materials and their conversion into finished goods. Some businesses have a longer production cycle while some have a shorter one. Duration and the length of the production cycle affect the amount of funds required for raw materials and expenses.
(vi) 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 creditworthiness of their clientele. A liberal credit policy results in a higher amount of debtors, increasing the requirement of working capital.
(vii) 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 a purchase, the working capital requirement is reduced.
(viii) Availability of Raw Materials: If the raw materials are easily and readily available, lower stocks will have to be maintained. On the other hand, when the raw materials are scarce or not readily available, higher stock levels have to be maintained, thus increasing the need for a working capital requirement.
(ix) Time Lag: It is also known as lead time and is an important factor when deciding how much working capital is required. The 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.
