Factors Determining Working Capital Requirement

Working capital requirement is influenced by various factors. In fact, any and every activity of a company affects the working capital requirements of the company. The magnitude of influence may be different. Some important of them are listed below:

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 a 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 working capital requirement.

Factors Determining Working Capital RequirementCompetition

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.

Credit Policy

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.

Raw Material Short Supply

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.

Net Cash Profit

Profit or retained earnings are one of the sources of working capital for the business. It will depend on net cash profits as to how much working capital financing is required from external sources.


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

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.

Price Levels

The price levels of inventory and other expenses such as labour 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
• Business Turnover
Current Assets Requirements
• Profit Planning and Control
• Repayment Ability
• Cash Reserves
• Operation Efficiency
• Change in Technology
• Firm’s Finance and Dividend Policy
• Attitude towards Risk 

Last updated on : August 31st, 2017

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