Ques : Describe Factor Influencing Working Capital Requirements

The working capital requirement of a firm depends upon various factors such as nature and size of business, the character of their operations, the length of production cycles, the rate of stock turnover and the state of the economic situation. It is very difficult to rank them because all such factors of different importance change for firm over time. However, the following are important factors generally influencing the working capital requirement. Let us discuss them in detail.

Nature of business: The working capital requirement of a firm is closely related to the nature of its business. In general businesses with short operating cycles will require lesser amount of working capital as compared to businesses with
longer operating cycles. The firms engaged in manufacturing and trading will require more working capital as large amount of funds are locked in inventories and receivables. In general utility companies and service companies (water
supply, electricity undertakings, telecom companies) will require lesser amount of working capital as compared to manufacturing and trading concern.

Business Cycle: During economic boom there is increased production which require higher amount of working capital, but this is partly off set by reduced operating cycle. At the time of economic recession again there would be need
for increased working capital, as large amount of funds would be locked in inventories and receivables.

Seasonal Variations: Commodities with seasonal demand results in increased level of working capital requirement. This could be offset by scaling down operations during the lean part of the year and increasing production prior to
demand period. Products manufactured with raw materials, the production of which is seasonal (agricultural products) would require higher amount of working capital.

Size of Business: Size of the firm is also a determining factor in estimating working capital requirements. The size of a firm may be measured either in terms of scale of operations, or assets or sales. Large firms require more
amount of working capital for investment in current assets and also to pay current liabilities than smaller firms. However, in some cases even a small firm may need more working capital as a cushion against cash flow interruptions.

Change of Technology: Changes in technology generally leads to improvements in the efficient processing of raw material, decrease in wastages, higher productivity and more speedy production. All these improvements lead
to reduction in investment in inventories, which in turn leads to reduction in working capital requirement. If changed technology results in shorter manufacturing process the lesser would be the requirements of working capital.

Length of Operating or Working Capital Cycle: As explained in the section dealing with operating cycle concept of working capital the amount of working capital will depend upon the duration of operating cycle. The operating cycle in
turn is dependent on many other variables such as length of manufacturing process, debtors’ collection period, etc.

Firms credit policy: The credit policy of the firm also impacts working capital needs. A firm following liberal credit policy will require more amount of working capital, as a large amount of funds would be blocked in debtors.