Some of the factors affecting the working capital of a company are as follows:
The firm must estimate its working capital very accurately because excessive working capital results in unnecessary accumulation of inventory and wastage of capital whereas shortage of working capital affects the smooth flow of operating cycle and business fails to meet its commitment.
So finance manager must estimate right amount of working capital. The finance manager must keep in mind following factors before estimating the amount of working capital.
The amount of working capital directly depends upon the length of operating cycle. Operating cycle refers to the time period involved in production. It starts right from acquisition of raw material and ends till payment is received after sale.
The working capital is very important for the smooth flow of operating cycle. If operating cycle is long then more working capital is required whereas for companies having short operating cycle, the working capital requirement is less.
The type of business, firm is involved in, is the next consideration while deciding the working capital. In case of trading concern or retail shop the requirement of working capital is less because length of operating cycle is small.
The wholesalers as compared to retail shop require more working capital as they have to maintain large stock and generally sell goods on credit which increases the length of operating cycle. The manufacturing company requires huge amount of working capital because they have to convert raw material into finished goods, sell on credit, maintain the inventory of raw material as well as finished goods.
The firms operating at large scale need to maintain more inventory, debtors, etc. So they generally require large working capital whereas firms operating at small scale require less working capital.
During boom period the market is flourishing so more demand, more production, more stock, and more debtors which mean more amount of working capital is required. Whereas during depression period low demand less inventories to be maintained, less debtors, so less working capital will be required.
The working capital requirement is constant for the companies which are selling goods throughout the season whereas the companies which are selling seasonal goods require huge amount during season as more demand, more stock has to be maintained and fast supply is needed whereas during off season or slack season demand is very low so less working capital is needed.
If a company is using labour intensive technique of production then more working capital is required because company needs to maintain enough cash flow for making payments to labour whereas if company is using machine-intensive technique of production then less working capital is required because investment in machinery is fixed capital requirement and there will be less operative expenses.
In case of production cycle, if production cycle is long then more working capital will be required because it will take long time for converting raw material into finished goods whereas when production cycle is small lesser funds are tied up in inventory and raw materials so less working capital is required.
Credit policy refers to average period for collection of sale proceeds. It depends on number of factors such as creditworthiness, of clients, industry norms etc. If company is following liberal credit policy then it will require more working capital whereas if company is following strict or short term credit policy, then it can manage with less working capital also.
Another factor related to credit policy is how much and for how long period company is getting credit from its suppliers. If suppliers of raw materials are giving long term credit then company can manage with less amount of working capital whereas if suppliers are giving only short period credit then company will require more working capital to make payments to creditors.
The firm having high degree of operating efficiency requires less amount of working capital as compared to firm having low degree of efficiency which requires more working capital.
Firms with high degree of efficiency have low wastage and can manage with low level of inventory also and during operating cycle also these firms bear less expense so they can manage with less working capital also.
If raw materials are easily available and there is ready supply of raw materials and inputs then firms can manage with less amount of working capital also as they need not maintain any stock of raw materials or they can manage with very less stock.
Whereas if the supply of raw materials is not smooth then firms need to maintain large inventory to carry on operating cycle smoothly. So they require more working capital.
If the market is competitive then company will have to adopt liberal credit policy and to supply goods on time. Higher inventories have to be maintained so more working capital is required. A business with less competition or with monopoly position will require less working capital as it can dictate terms according to its own requirements.
If there is increase or rise in price then the price of raw materials and cost of labour will rise, it will result in an increase in working capital requirement.
But if company is able to increase the price of its own goods as well, then there will be less problem of working capital. The effect of rise in price on working capital will be different for different businessmen.
Firms planning to expand their activities will require more amount of working capital as for expansion they need to increase scale of production which means more raw materials, more inputs etc. so more working capital also.