Working Capital

WORKING CAPITAL

Those funds needed for meeting day-to-day operations affect the liquidity and profitability of the business.

Formulae = current assets – current liability

Current Assets

• Converted into cash within a period of one year without a reduction in value.
• EXAMPLE Cash at Bank  Marketable securities, Debtors

Current Liability

• The payment which is due for payment within one year; \
• Example bills payable, creditors, bank overdraft.

Types Working Capital

• Gross working capital: - total fund invested in the current assets.
• Gross working capital = current assets
• Networking capital: excess of current assets over current liabilities.= current assets – current liability

Major ingredients of working capital

• Cash management
• Inventories management
• Debtors management

Factors affecting the working capital requirements:

1. Nature of Business:        
   • In trading concerns, there is no processing that requires less working capital. Etc wholesale business
   • Service industries do not have to maintain inventory and require less working capital. Example transportation, tourism, education, etc
   • In manufacturing concern raw material is to convert into finished good requires more working capital. Steel, car manufacturing, cement, etc.
2. Scale of Operations: Organizations operate on a higher scale of operation, the amount of inventory and debtors required is generally high and requires a large amount of working capital.
3. Business Cycle: In case of a boom, the sales, as well as production, are higher and therefore, a higher  amount of working capital is required and vice-versa
4. Seasonal Factors: In peak season, a higher level of activity, and a higher amount of working capital are required. As against this, the level of activity, as well as the requirement for working capital, will be lower during the thin season.
5. Production Cycle. Some businesses have a longer production cycle while some have a shorter one. Therefore, the working capital requirement is higher in firms with longer processing cycles and lower in firms with shorter processing cycles.
6. Credit Allowed: Different firms allow different credit terms to their customers. A liberal credit policy results in a higher amount of debtors, increasing the requirement for working capital.
7. 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 its purchases; the working capital requirement is reduced.
8. Operating Efficiency: Firms manage their operations with varying degrees of efficiency. Such efficiencies may reduce the level of raw materials, finished goods and debtors resulting in lower requirements for working capital.
9. Availability of Raw Material: If the raw materials and other required materials are available freely and continuously, lower stock levels may be sufficient or vice-versa.
10. Growth Prospects: For a firm with a growth prospect of concern is perceived to be higher, it will require a higher amount of working capital so that is able to meet higher production and sales target whenever required.
11. Level of Competition: A higher level of competitiveness and liberal credit terms require a higher amount of working capital in a stock of finished goods, credit sales, advertisement
12. Inflation: rising prices of input cost like labor, raw material, rent, and interest higher amounts of working capital is required to meet higher cost or vice-versa.

Factors affecting the working capital requirements: