9 Determinants of Working Capital of a Company| Financial Management

Some of the major determinants of working capital are discussed below:

A company, as a general policy, wants to hold in balance as small a quantity of working capital as possible so long as undue solvency risks are not imposed on it. This is a logical approach indicating that working capital is a means to an end and not an end in itself.

Quantitative amounts of working capital can hardly be set for individual firms. The corporate management has to consider the various factors in making decision regarding balances. An appraisal of these would provide guidance to management in estimating prospective needs. These are called as determinants of working capital.

The following paras bring about them in detail:

1. Nature of business:

A company’s working capital requirements are basically related to the kinds of business it conducts. Generally speaking, trading and financial firms require relatively large amounts of working capital, public utilities comparatively small amounts, whereas manufacturing concerns stand between these two extremes, their needs depending upon the character of industry of which they are a part.

2. Production policies:

Depending upon the kind of items manufactured, a company is able to offset the effect off- seasonal fluctuations upon working capital by adjusting its production schedules. The choice rests between varying output in order to adjust inventories to seasonal requirements and maintaining a steady rate of production and permitting stocks of inventories to build up during off-season periods. It will thus be obvious that a level production plan would involve a higher investment in working capital.

3. Manufacturing process:

If the manufacturing process in an industry entails a longer period because of its complex character, more working capital is required to finance that process. The longer it takes to make an approach and the greater its cost, the larger the Inventory tied up In Its manufacture and, therefore, higher the amount of working capital.

4. Turnover of circulating capital:

The speed with which the circulating capital completes its round I.e., conversion of cash into inventory of raw material Into Inventory of finished goods. Inventory of finished goods into book debts or accounts receivables and book debt into cash account, plays an Important and decisive role in judging the adequacy of working capital.

5. Growth and expansion of business:

As a company grows, it is logical to expect that larger amount of working capital will be required though It Is difficult to draw up firm rules for the relationship between the growth in the volume of a company’s business and the growth of its working capital.

6. Business cycle fluctuations:

Requirements of working capital of a company vary with the business variation. At a time when the price level comes up and boom condition prevail, the psychology of the management is to pile up a big stock of raw material and other goods likely to be used in the business operations as there is an expectation to take advantage of lower prices. The expansion of business units caused by the inflationary conditions creates demand for more and more capital.

7. Terms of purchase and sales:

A business unit, making purchases on credit basis and selling its finished products on cash basis, will require lower amount of working capital, on the contrary, a concern having no credit facilities and at the same time forced to grant credit to its customers may find itself in a tight position.

8. Dividend policy:

A desire to maintain an established dividend policy may affect working capital, often changes in working capital bring about an adjustment of dividend policy. The relationship between dividend policy and working capital is well established and very few companies declare a dividend without giving due consideration to its effects on cash and their needs for cash.

A shortage of working capital often acts as a powerful reason for reducing or skipping a cash dividend. On the other hand, a strong position may justify continuing dividend payment.

9. Other determinants:

The following are the other determinants of working capital:

i) Absence of co-ordination in production and distribution policies in a company results in a high demand for working capital.

ii) The absence of specialisation in the distribution of products may enhance the need of working capital.

iii) If the means of transport and communication in a country like India are not well-developed, the industries may face a great demand for working capital in order to maintain big inventory of raw materials and other accessories.

iv) The import policy of the Government may also effect the requirement of the working capital for the companies as they have to arrange for funds for imposing the goods at specified times.

v) The hazards and contingencies inherent in a particular type of business decide the magnitude of working capital in terms of keeping liquid resources.

Submitted by : Professor Addison, Category : Company, Tag : Company