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What are the determinants of Working Capital?

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Determinants of Working Capital

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Determinants of Working Capital: The working capital of any firm depends upon the nature of business it has. If it is any public organization like Railways, Electricity Board, etc.

On the other hand, if this organization is any manufacturingand trading firm, then it requires a huge amount of working capital to run their organization effectively. Length of the manufacturing cycle decides the amount of working capital required for the firm.

If the manufacturing cycle is less, then the working capital requirement will be less. In other words, if the manufacturing cycle is more, the requirement of working capital will be high.

In this context, every organization try to precise their manufacturing cycle to have accurate balance of working capital. For determining the working capital of an organization, production policies are much important. If the organization is labor-intensive, then it requires minimal working capital. If the organization works on automation, it requires a huge amount of working capital.

If an organization allows continuous credit by its suppliers, it is expected to the postponement of the payment. Where the cost of raw materials to be used in manufacturing of a product is very large in proportion to the total cost and its final value, working capital required will also be more.

That is why, in a cotton textile mill or in a sugar mill, huge funds are required for this purpose. A building contractor also needs huge working capital for this reason.

If the importance of materials is less, as for example in an oxygen company, the needs of working capital will be naturally not more. In labour intensive industries, larger working capital will be required than in the highly mechanized ones. The latter will have a large proportion of fixed capital. It may be remembered, however, that to some extent the decision to use manual labour or machinery lies with the management.

Therefore, it is possible in most cases to reduce the requirements of working capital and increase investments in fixed assets and vice versa. The manufacturing concerns generally have to carry stocks of raw materials and other stores and also finished goods. The larger the stocks whether of raw materials or finished goods more will be the needs of working capital.

In certain lines of business, e. Similarly, in public utilities, which must have adequate supplies of coal to assure regular service, stock piling of coal is necessary.

In seasonal industries finished goods stocks have to be stored during off seasons. All these require large working capital. Turnover means the speed with which the working capital is recovered by the sale of goods. In certain businesses, sales are made quickly and the stocks are soon exhausted and new purchases have to be made.

In this manner, a small amount of money invested in stocks will result in sales of much larger amount. Considering the volume of sales, the amount of working capital requirements will be rather small in such type of business. There are other businesses where sales are made irregularly. Between two firms carrying on same type of business, working capital requirement will vary depending upon the level of activity or scale of operation. Firms operating at higher activity level will require more working capital than others operating say, at a lower level of activity.

Therefore the scale of operation will also govern the working capital requirement of a firm. This means the time involved in manufacturing or processing a product. It may be stated that longer the production cycle the larger will be the funds tied up in inventories and consequently larger will be the need for working capital and vice versa.

The length of production cycle however, depends upon the nature of its business. Sometimes, firms manufacturing heavy machinery and equipment may minimize their investment in inventories or working capital by requiring advance payment from their customers against work orders. The nature of business cycle will have a bearing on the working capital requirement of a firm. The fluctuations in operations may be in two directions: During the upswing need for working capital will increase to meet the requirements of increased production and sales.

On the other hand during downswing the volume of working capital will automatically come down. Seasonality and production policy: When demand for a product or service of a firm is of a seasonal nature, the working capital requirement will be determined having regard to production policy of the firm to meet the seasonal fluctuations.

In other words in case of seasonal demands there may be two alternative approaches: Thus in case of the former, there will be larger accumulation of finished goods during the off-season. This will require an increasing amount of working capital, which will remain tied-up during this period. In the latter case, inventories are kept at minimum levels during off-season and during peak season it has to be adjusted to additional demands.

Thus the requirement for working capital will fluctuate along with fluctuating production policy having regard to seasonal nature of demand. The credit policy of a firm governing sales and purchases will influence the volume of working capital. It may be observed that working capital requirement decreases as the credit period for the realization of debtors is reduced and on the other hand the period of repayment of creditors is enhanced.

However, while planning working capital requirement, the credit policy to be adopted by a firm should be taken into account and its impact on working capital requirement should be assessed. With the growth of firms capital expenditures are incurred to expand their capacity.

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The requirements of working capital are not uniform in all enterprises, and therefore, factors responsible for a particular size of working capital in one company are different than in other ct4uc3541.cfore, a set pattern of factors determining the optimum size of working capital is difficult to suggest.

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The determinants of working capital are items that have a direct impact on the amount invested in current assets and current liabilities. Managers like to keep a close watch over these factors, since working capital can absorb a large part of the funding that an organization has at its disposal.

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Determinants of Working Capital There are no set rules or formulate to determine the working capital requirements of a firm. The corporate management has to consider the various factors in making decisions regarding working capital balances. Please do send us the Determinants of Working Capital problems on which you need Help and we will forward then to our tutors for review. Online Live Tutor Determinants of Working Capital: We have the best tutors in finance in the industry.

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The amount of working capital needed is highly influenced by the length of manufacturing cycle. If the manufacturing process is long, huge amount of working capital will be required and vice versa. so utmost care should be taken to shorten the period of cycle in order to minimize the working capital requirements. In analyzing the determinants of working capital management, Chiou and Cheng (), found that there is an inverse relationship between capital structure of the firm and the two measures of liquidity: net liquid balance and working capital ratio.