There are no set formulates to determine the working capital requirements of firms. A large no. of factors each having a different importance, influence working capital needs of firms. However, the factors may vary from organization to organization. Therefore, an analysis or relevant factors should be made in order to determine total investment in working capital. The following is the description of factors, which generally influence the working capital requirement of firms.
Nature of Business: - Business firm can be dividend in to three categories given below: -
Service organization or public utilities
Trading or financial organization
Manufacturing organization
Service organizations don’t normally hold any inventory or the level inventory may be very low. Again major sale of such services are on cash basis. Hence they require very less amount of working capital. Trading or financial organization have to maintain sufficient amount of cash and inventory. Hence working capital requirement of such organization are relatively very high. Working capital requirement of manufacturing organization normally falls between the above two extremes.
.Volume of sales: - The higher the sales on credit basis, the higher is the requirement of working capital, as more and more amount is getting blocked in debtors
Manufacturing Cycle: - The manufacturing cycle refers to the time spent by a product right from the stage of purchase of its raw material to the stage of completion of finished goods. Obviously the larger the manufacturing cycle of a company the higher is the volume of working capital needed to finance blockage of money in raw material, work in progress and finished good.
Business Cycle: - No business can remain study for all the time. It passes through the stages of prosperity and depression. During Prosperity, the volume of sales increases necessitating higher level of inventories and debtors, i.e. more Amount of working capital is required to sustain higher levels of activity during prosperity. Depression has exactly an opposite effect on the level of working capital requirement.
Credit Policy: - If the organization is following a liberal credit p[policy for its customers, it will result in higher debtors leading to requirement of more working capital. However, if the organization is availing liberal credit term from its suppliers, the need for working capital is reduced.
Tax Structure: - The entire profit generated may not be available to the organization because of a simplest fact. The organization has to pay its taxes in time. Tax rates vary in different forms of organization and accordingly working capital requirement of different organization will be different.
Dividend Payout ratio: - If dividend payout ratio is high, the organization may have earned profit but-the profits available only after payment of dividends is available for financing working capital. Hence, higher working capital will be required if Dividend payout ratio is high.
Availability of Funds: - If the credit worthiness of an organization is good, it may manage the business with less Working Capital. The reason may be that the organization may procure the funds whenever it needs the funds.
Change in Technology: - Change in technology affect the requirement for working Capital. If the firm decides to go for automation, this would reduce the requirements of Working Capital. If the firm adopts a labor-intensive process, the requirement of working capital will be larger.
Size of the Firm: - Bigger firms may require lesser working capital as compared to their total sales or assets. Of course the absolute amount of working capital will be higher in bigger firms. The level of Working Capital is determined by a wide variety of factors that are partly internal to the firm and partly external to it. Efficient working capital management requires efficient planning and a constant review of the needs for an appropriate working capital strategy
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