Introduction to Corporate Finance — Secretarial Practice STD 12 Commerce / Arts — Question

Factors determining/influencing working capital requirements are as follows:
(i) Nature of Business:
The working capital requirements are highly influenced by the nature of the business. Trading/ merchandising forms concerned with the distribution of goods require a huge amount of working capital to maintain a large stock of the variety of goods to meet customers’ demands are extend credit facilities to attract them. Whereas public utility concerns have to maintain small working capital because of a continuous flow of cash from their customers.

(ii) Size of business:
The size of a business also affects the requirements of working capital. Size of the firm refers to the scale of operation i.e. a firm with large scale operations will require more working capital and vice versa.

(iii) Volume of Sales:
The volume of sales and the size of the working capital have a direct relationship with each other. If the volume of sales increases there is an increase in the amount of working capital.

(iv) Production cycle:
The process of converting raw material into finished goods is called the ‘production cycle’. If the production cycle period is longer, the firm needs more amount of working capital. If the manufacturing cycle is short, it requires less working capital.

(v) Business cycle:
When there is a boom in the economy, sales will increase resulting in to increase in investment in stock. This will require additional working capital. During a recession period, sales will decline and consequently, the need for working capital will also decrease.

(vi) Terms of purchases and sales:
If credit terms of purchase are favourable and terms of sales are less liberal, then the requirement of cash will be less. Thus, the working capital requirement will be reduced.
A firm that enjoys more credit facilities needs less working capital. On the other hand, if a firm does not get proper credit for purchases and adopts a liberal credit policy for sales if requires more working capital.

(vii) Credit Control:
Credit control includes the factors such as volume of credit sales, the terms of credit sales, the collection policy etc. A firm with a good credit control policy will have more cash flow reducing the working capital requirement. Whereas if the firm’s credit policy is liberal there would be more requirements of the working capital.

(viii) Growth and Expansion:
Those firms which are growing and expanding at a rapid pace need more working capital compared to those firms which are stable in their growth.

(ix) Management ability:
The requirement of working capital is reduced if there is proper coordination in the production and distribution of goods. A firm stocking on heavy inventory calls for a higher level of working capital.

(x) External factors:
If the financial institutions and banks provide funds to the firm as and when required, the need for working capital is reduced.