5. FACTORS AFFECTING WORKING CAPITAL:
There is no definite formula by which the proper level of working capital can be determined. Ordinarily, due to rapid expansion of business a major part of a company may get locked up in fixed assets so that little funds are available to satisfy the working capital requirements. Under the circumstances, a company is bound to borrow funds at a high rate of interest, which creates a financial burden of the company. The general empirical principal is a business, which can generate cash quickly and easily and does not resort to long term borrowing for meeting working capital requirements. A company should always leave a sufficient margin of current assets over current liabilities to make sure that a company is able to meet such financial obligations as interest payments, dividends on preferred stock, wage bills, taxes etc. it is known that the requirements of a business are not always the same. They vary not only from year to year but also from month to month.
In order to determine the proper need of working capital the following factors should be carefully considered:
2) Size of business unit: It is an important factor for determining the proportion of working capital. The general principal in this connection is that the bigger the size of the unit, the more will be the amount of working capital required. But it is quite likely that the bigger sized business unit, i.e., a consumers’ goods industry may require a larger amount of fixed capital than working capital.
3) Time consumed manufacture: The longer the period of manufacture, the larger the inventory required. However, if the flow of product is quite steady, although the value of goods in process is large, the working capital will not vary much from time to time.
4) Need to stock pile raw materials: Those concerns where there is the need to stock pile raw materials require larger amount of working capital. The necessity for stock piling increases the extent of funds tied up in inventories.
5) Need to store finished goods: In business like retail stores, where unit is required to store finished goods, (because in the absence of adequate stocks, customer may return disappointed) naturally more working capital is required.
6) Cost and time involved in the manufacturing process: If the manufacturing process in an industry entails high cost because of its complex nature, more working capital will be required to finance that process and also for other expense which vary with the cost of production. Moreover, the longer the period of manufacture, higher the amount of cash needed.
7) Turnover of circulating capital: Turnover of circulating capital plays an important and decisive role in judging the adequacy of working capital. The speed with which the circulating capital completes its round, i.e., conversion of cash into book debts or bills receivables, and book debts or bills receivables into cash again plays an important role.
8) Terms and conditions of purchase and sale: The place given to credit by a concern in its dealings with creditors and debtors may also be considered to assess the adequacy of working capital. A business unit, making purchase on credit basis and selling its finished products on cash basis, will require lower amount of working capital than a concern having no credit facilities and which may further be forced to grant credit to its customers.
9) Conversions of current assets into cash: A company having ample stock of liquid current assets will require lesser amount of working capital, because adequate funds can easily be procured by disposed of current assets are much more than the current liabilities.
10) Impact of cyclical and seasonal variation: In periods of the boom and depression, more working capital is needed than during the other stages of cyclical fluctuations.
For arriving at a satisfactory working capital position in time of prosperity the firm should conserve current capital by avoiding wasteful expenditure. When inflationary pressure has been created during a period of emergency like a war, unnecessary hoarding should be avoided because such periods of rising prizes are temporary.
During a period of recession, production is disturbed due to scarcity of materials. The current assets should be converted into cash without creating new financial obligations by borrowing at a high rate of interest. During periods of long lasting depression, excessive stocks are accumulated and fund of the companies are locked up. As a result, any addition to working capital by way of borrowing is undesirable. Attempts should be directed to convert current assets into cash.
During the period of recovery, the fixed capital and working capital requirements of industry will increase. During the period of recovery when the concern starts earnings of the company should be earmarked for meeting additional requirements. When the business of a company has expanded and the concern has substantially good banking connections and enjoys prestige commercial banks, with it may rely on financing temporary expansion of current assets with the help of bank loan.
11) Other factors: There are number of factors affecting the adequacy of working capital. In the absence of coordination working capital may be needed. An expanding business will require increase in working capital proportionate to the rate of expansion.
