Factors Affecting the Working Capital - GeeksforGeeks (2024)

Excess of current assets of an organisation over its current liabilities is known as Working Capital. Simply put, it is the finance available to an organisation for its day-to-day business operations. It can also be defined as that part of the total capital, which is required for holding current assets.

1. Nature of Business

The first factor which helps in determining the requirement of working capital is the type of business in which the company is involved. A trading company or a retail shop requires less working capital as the length of the operating cycle of these types of businesses is small. However, the wholesalers require more working capital, as they have to maintain a large stock and generally sell goods on credit, increasing the length of the operating cycle. Besides, a manufacturing company requires a huge amount of working capital as it has to convert its raw materials into finished goods, sell the goods on credit, and maintain the inventory of raw materials and finished goods.

2. Scale of Operation

The firms that are operating at a large scale need to maintain more debtors, inventory, etc. Hence, these firms generally require a large amount of working capital. However, the firms that are operating at a small scale require less working capital.

3. Business Cycle Fluctuation

A market flourishes during the boom period which results in more demand, more stock, more debtors, more production, etc., ultimately leading to the requirement for more working capital. However, the depression period results in less demand, less stock, fewer debtors, less production, etc., which means that less working capital is required.

4. Seasonal Factors

The companies which sell goods throughout the season require constant working capital. However, the companies selling seasonal goods require a huge amount of working capital during the season, as at that time there is more demand, and the firm has to maintain more stock and supply the goods at a fast speed, and during the off-season, it requires less working capital as the demand is low.

5. Technology and Production Cycle

A company using labour-intensive techniques requires more working capital because it has to maintain enough cash flow for making payments to labour. However, a company using capital-intensive techniques requires less working capital because the investment made by the company in machinery is a fixed capital requirement, and also there will be less operating expenses.

6. Credit Allowed

The average period for collection of the sale proceeds is known as the Credit Policy. The credit policy of a company depends on various factors like the client’s creditworthiness, industry norms, etc. A company following a liberal credit policy will require more working capital, as it is giving more time to the creditors to pay for the sale made by the company. However, if a company follows a strict or short-term credit policy then it will require less working capital.

7. Credit Avail

The time period that a company is getting credit from its suppliers also affects the requirement for working capital. If a company is getting long-term credit on raw materials from its supplier, then it can manage well with less working capital. However, if a company is getting a short period of credit from its suppliers, then it will require more working capital.

8. Operating Efficiency

If a company has a high degree of operating efficiency then it will require less working capital; however, if a company has a low degree of operating efficiency then it will require more working capital. (Operating cycle of a firm is the time period from the purchase of raw material to the realisation from debtors). Hence, it can be said that the length of the operating cycle directly affects the requirements of the working capital of an organisation.

9. Availability of Raw Materials

If the raw material is easily available to the firm and there is a ready supply of inputs and raw material, then the firm can easily manage with less working capital. Also, as the firm does not need to maintain any stock of raw materials, they can manage with less stock, and hence less working capital. However, if there is a rough supply of raw materials, then the firm will have to maintain a large inventory to carry on the operating cycle smoothly. Therefore, the firm will require more working capital.

10. Level of Competition

If there is competition in the market, then the company will have to follow a liberal credit policy for supplying goods on time. For this, it will have to maintain higher inventories, resulting in more working capital requirements. However, if there is less competition in the market or a company is in a monopoly position, then it will require less working capital, as it can dictate its own terms according to its requirements.

11. Inflation

A rise in the price increases the price of raw materials and the cost of labour, resulting in the increasing requirement for working capital. However, if a company is able to increase the price of its goods also, then it will face less problem with working capital. A rise in price has a different effect on the working capital of different businesses.

12. Growth Prospects

If a firm is planning on expanding its activities then it will require more working capital, as it needs to increase the scale of production for expansion, resulting in the requirement of more inputs, raw materials, etc., ultimately increasing the need for more working capital.