Working capital requirement is influenced by various factors. Majority activities of the company affect the working capital requirements of the company. The magnitude of influence may be different. Some important of them are listed below:
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Factors Influencing Working Capital Management
Nature of the Industry / Business
The management of working capital is completely different from industry to industry. A simple comparison of the service industry and manufacturing industry can clarify the point. In the service industry, there is no inventory and therefore, one big component of working capital is already avoided. So, the nature of the industry is a factor in determining the working capital requirement.
Seasonality of Industry and Production Policy
Businesses based on seasons like manufacturing of ACs whose demand peaks in summer and dips in winter. The requirement of working capital will be more in summer compared to winter if they are produced in the fashion of their demand. The policy of producing throughout the year can smoothen the fluctuation of the working capital requirement.
If the industry is competitive, quick response to customer needs is compulsory and therefore a higher level of inventory is maintained. Liberal credit terms are also mandatory with good service to survive in the market. So, higher the competition, higher would be the requirement of working capital.
Production Cycle Time
The production cycle time refers to the time required for converting the raw materials into finished goods. Higher, this time, higher would be the time of blocking funds in the working capital.
Liberal credit policy demands a higher level of working capital and tight credit policy reduces it.
Growth and Expansion
Some industries are static and others are growing. Obviously, growing industry grows the requirement of working capital also as compared to static industry.
Shortage of supply of Raw Material
If the raw material supply is not smooth for any reason, companies tend to store more of raw materials than needed and that increased requirement of working capital.
Taxes are often paid in advance. This also blocks a part of working capital. Depending on the tax environment of the industry, working capital needs are also affected.
Dividend policy determines the level of retained profits with the business and retained profits are also used for working capital. This is how; dividend policy affects the need for working capital.
The price levels of inventory and other expenses such as labor rates etc increase the working capital requirement. If the company also is able to increase the price of their finished goods, it reduces this impact.
Other factors that determine or impact the working capital in some or the other way are as follows:
- Cash Requirements
- Volume of Sales
- Terms of Purchase and Sales
- Inventory Turnover
- Current Assets Requirements
- Operation Efficiency
- Change in Technology
- Firm’s Finance and Dividend Policy
- Attitude towards Risk
- Raw material Holing period.
- Work In Progress Holding period
- Finished Goods Holding Period.
- Average Collection Period.
- Average Payment Period.
- Working Capital Cycle.
- Safety Stock of Raw Material.
- Cash Balance to be maintained.