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Determinants of Working Capital

>> April 26, 2010

1. Small or Large Business

It is the first determinant of working capital that it is affected with the nature of business. Business may be small or large. In small business, company need high working capital because, small business is relating to trading of goods, for starting small business, you need very small fixed capital but need high working capital for paying day to day expenses. But in large business, we require more fixed capital than working capital for purchasing fixed asset.

2. Small or Large Demand

Nature of demand also absolutely affects the working capital need. Some product can be easily sold by businessman, in that business; you need small amount of working capital because your earned money from sale can easy fulfill the shortage of working capital. But, if demand is very less, it is required that you have to invest large amount of working capital because your all fixed expenses must be paid by you.
For paying fixed capital you need working capital.

3. Production Policy

Production policy is also main determinant of working capital requirement. Different company may different production policy. Some companies stop or decrease the production level in off seasons, in that time, company may also reduce the number of employees or decrease the purchasing of new raw material, so, it will certainly decrease the amount of working capital but on the side, some company may continue their productions in off season, in that case, they need definitely large amount of working capital.

4. Credit Policy

Credit policy is relating to purchasing and selling of goods on credit basis. If company purchases all goods on credit and sells on cash basis or advance basis, then it is certainly company need very low amount of working capital. But if in company, goods are purchased on cash basis, and sold on credit basis, it means, our earned money will receive after sometime and we require large amount of working capital for continuing our business.

5. Dividend Policy

Dividend policy also effect working capital requirement. Company can distribute major part of net profit. But, if there is no reserve, we have to invest large amount in working capital because, lacking of reserve will affect on adversely on fulfill our liabilities. In that case, we have to yield working capital by taking short term loan for paying uncertain liability.

6. Working Capital Cycle

Working capital cycle shows all steps which starts from cash purchasing of raw material and then this converted into finished product, after this it is converted into sale, if it is credit sale, debtors will also the part of working capital cycle and when we gets money from our debtors, it is the final part of working capital cycle. If we receive fastly from our debtors, we need small amount working capital. Otherwise, for purchasing new raw material, we need more amount of working capital.

7. Manufacturing Cycle

Manufacturing cycle means the process of converting raw material into finished product. Long manufacturing cycle will create the situation in which we require large amount of working capital. Suppose, we have to construct the building, for constructing colony of buildings, it may consume the time more than 5 years, so according to this we need working capital.

8. Business Cycle

There are two main part of business cycle, one is boom and other is recession. In boom, we need high money or working capital for development of business but in recession, we need only low amount of working capital.

9. Price Level Changes

If there is increasing trend of products prices, we need to store high amount of working capital, because next time, it is precisely that we have to pay more for purchasing raw material or other service expenses. Inflation and deflation are two major factors which decide the next level of working capital in business.

10. Effect of External Business Environmental Factors

There are many external business environmental factors which affect the need of working capital like fiscal policy, monetary policy and bank policies and facilities.

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