What is Working Capital? State factors affecting requirement of working capital.

Answer: Working Capital and Factors Affecting Requirement.

Meaning of Working Capital:

Working capital means current assets or circulating capital. Experts define working capital in both, narrow as well as broad sense. In the narrow sense, it is defined as “the difference between current assets and current liabilities”.

According to Gerstenbergh, “working capital is the excess of current assets over current

liabilities”. However, Gerstenbergh prefers to call working capital as circulating capital.

In a broader sense, working capital has been defined as follows:

According to Western and Brigham, “working capital refers to a firm’s investment in short term assets such as cash, short term securities, account receivable and inventories”.

As per Mead, Baker and Mallot, “working capital means current assets”.

As per J. S. Mill, “the sum of current assets is working capital of a business”.

It takes into account all current resources of the company. It refers to ‘gross working capital’.

Factors affecting Working Capital Requirement: 

The factors affecting working capital requirement are as follows:

i. Business Cycle:

When there is boom in the economy, sales will increase, which will lead to an increase in investment in stock.
Hence, additional working capital would be required. During recession period, sales would decline and the need of working capital would also decrease.

ii. Requirement of Cash:

The requirement of working capital depends upon the cash required by the organization for various purposes. If the requirement of cash is more, then company requires more working capital and viceversa.

iii. Growth and Expansion Activities:

The working capital requirement increases with the growth of firm. It needs funds continuously to support large scale operation.

iv. Seasonal Fluctuations:

The requirement of working capital depends upon the seasonal fluctuations. It states that, if the demand for the product is seasonal, the working capital required in that
season will be more.

For e.g. The demand for sweaters is more in winter. Sweater manufacturing companies need more working capital before winters to make the goods available in the market before the season starts.

v. Production Cycle:

The process of converting raw material into finished goods is called ‘production cycle’. A firm requires more working capital when the production cycle is longer and vice versa.

vi. External Factors:

If the financial institutions and banks provide funds to the firm as and when required, the need of working capital will be reduced.

vii. Credit Control:

Volume and terms of credit sales, collection policy etc. are the important factors of credit control. Sound credit policy improves cash flow and hence the firms making cash sales require less working capital. Liberal credit policy increases the risk of bad debts and hence the firms selling on easy credit terms may require more working capital.

viii. Terms of Purchase and Sales:

If the credit terms of purchases are favourable and terms of sales are less liberal then the requirement of working capital will reduce as the requirement of cash will be less. On the other hand, if the firm does not get proper credit for purchase and adopts liberal credit policy for sales, it will require more working capital.

ix. Size of Business:

The size of business has a great impact on the requirement of working capital. Large scale firms require large amount of working capital.

x. Volume of Sale:

The volume of sale is directly proportional to the size of working capital. If the volume of sale increases, there is an increase in amount of working capital and vice versa.

xi. Management Ability:

The requirement of working capital will reduce if there is proper co‐ordination between production and distribution of goods. Lack of co‐ordination between different departments may result in heavy stocking of finished and semi‐finished goods, which ultimately leads to an increase in the requirement of working capital.

xii. Nature of Business:

The nature of business highly influences the requirement of working capital. Industrial and manufacturing enterprises, trading firms, big retail stores etc. need a large amount of working capital as they have to satisfy varied and continuous demands of consumers.

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