Determinants of Working
Capital Or Factors which
determine the need for Working Capital

Determinants of Working
Capital Or Factors which
determine the need for Working
Capital

There is no specific rule or formula to determine the need for working capital. There are many factors which af fect the working capital need of firms. Following are the which generally influence the working capital require factors ments of the firm:

1. Nature and size of the business- Working capital requirements of a firm are influenced by the nature of the business. Firms which are involved in trading, have a very small investment in fixed assets but it requires a large sum of money to be invested in working capital. For example, a retail store is required to maintain large stock of a variety of goods, so it will need sufficient working capital. On the other hand, companies relating to public utilities have a limited need for working capital but they are required to invest large sum in fixed assets.

Similarly, size of the business also has important effect on working capital needs. If the size of the business is large, it will need more working capital than a small firm.

2. Volume of sale- The working capital need of the firm also increases with its sales volume. We can not exactly determine the relationship between volume of sales and working capital needs. Therefore, it is necessary to make advance planning of working capital for a growing firm.

When a firm invests funds in fixed assets in order to increase sale and production, it will increase investment in current assets also. Otherwise such a firm faces financial problems and it would not be able to pay dividend to shareholders. It is therefore, necessary to make proper planning by such companies to satisfy the needs for working capital

3. Condition of Demand-Generally, there is a fluctuation in the demand of the products and services. Due to variation in business, the demand for working capital will also in crease. The firm’s investment in stock and debtors will also increase. If the additional investment in fixed assets is made, the working capital requirement will also increase. On the other hand; if there is a decline in economy, the sales will fall and so the level of stock and debtors will also fall. Such type of fluctuations i in economy will not only affect the working capital requirement but also create production problems for the firm. If there is a sudden increase in demand, the cost of production will be higher, similarly during low demand also the production will be expensive because it is required to maintain labour force without adequate work. Therefore, a firm should try to maintain a particular level of production in both situation. During slack season, funds will be required to maintain the level of production. So financial arrangement must be made in advance.

4. Credit policy of the Firm- The credit policy of the firm also affects the working capital requirements. Normally the credit facility is given according to the standard rules of that particular industry. A firm should be very careful in granting credit to its customers. If the firm has followed a liberal credit policy without giving proper attention to the creditworthiness of the customers, it will fatal for the firm. The firm should be very prompt in collection. If the average collection period is too much, it will increase the chances of bad debts.

5. Manufacturing Cycle- Manufacturing cycle starts from purchase of raw material and ends with production of finished goods. If the manufacturing cycle is longer, the working capital requirement will be large: It is also required that manufacturing cycle should be completed within specified time period. If there is any delay in the process, the work in progress will aecumulate and there will be wastage of time. In order to reduce working capital needs, some manufactures take advance payment from their customers.

6. Change in Price Level-Change in price level also creates problems to the financial manager. If the level of price increasing, the requirement of working capital will also increase. But if the firm can revise its rate immediately with increase in price level, it will not face the working capital problem so seriously. It is also possible that some companies will not be affected by rise in prices while other may be badly affected by it. The effect of change in price level will be different for different companies. Some will, face no working capital problem but other may face it seriously.

7. Efficiency and Performance- The pressure of working capital is also affected by the fact that how efficiently, it

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