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Factors affecting Working Capital
- 1. FACTORS AFFECTING WORKING CAPITAL Nisha G K II semester, A Batch
- 2. Nature of business Production Cycle Business Cycle Production Policy Credit Policy Growth and Expansion Availability of Raw Materials Profit Level Price Level Changes Operating Efficiency
- 3. 1. NATURE OF BUSINESS PublicUtilities •Cash nature of business; sale of service rather than commodities •Low working capital requirement Trading&Financial enterprises •Maintain sufficient amount of cash, inventories and book debts •Large working capital requirement Manufacturingfirms •Fall between the two extremes •Some require large amounts of working capital
- 4. 2. PRODUCTION CYCLE Procurement of raw materials Finished goods • Longer production cycle More working capital • Shorter production cycle Less working capital
- 5. 3. BUSINESS CYCLE • Increased sales and production • Purchase of additional materials • More working capital • Decreased sales and production • Fall in level of inventories • Less working capital
- 6. Production only during peak period Steady production policy 4. PRODUCTION POLICY
- 7. 5. CREDIT POLICY Credit terms granted by the firm to its customers Credit sales will result in higher book debts; hence more working capital Credit Allowed Credit terms available to the firm from its creditors If liberal credit terms are available from suppliers, need for working capital will be less Credit Availed
- 8. 6. GROWTH AND EXPANSION Growth potential - higher Higher production and sales target More working capital
- 9. 7. AVAILABILITY OF RAW MATERIALS Raw materials available freely and continuously Lower stock levels are maintained Less working capital Interrupted availability of raw materials Higher stock levels may be required More working capital
- 10. 8. PROFIT LEVEL Profit margin •High profit margin means more internal funds •Contributing to working capital pool Level of Taxes •Tax cannot be avoided but can be reduced •Tax planning Dividend policy •Low dividend means unhappy shareholders •High dividend means less retained profits
- 11. 9. PRICE LEVEL CHANGES Rising prices Higher amounts required to maintain constant volume of production and sales More working capital
- 12. 10. OPERATING EFFICIENCY Higher efficiency Profitability increases Improves working capital turnover
- 13. THANK YOU
Editor's Notes
- What is working capital- 2 concepts- gross and net Gross WC – aka WC- means total CA Net- diff between CA and CL In terms of ratio WC ratio is the ratio of CA to CL Ideally A firm should plan its operations in such a way that it should have neither too high nor too low WC ratio Not too low as it means company’s current assets are not sufficient to cover their near term obligations. Not too high as it means the company is letting excess cash and other assets just sit idly rather than actively investing its available capital in expnding the biz. This indicates poor financial management and lost biz opportunities The total of WC requirement is determined by a wide variety of factors. However it should be noted that these factors affect different enterprises differently and they also vary from time to time
- Public- Electricity and transport corporations. Two important features of public utilities are- 1) cash nature of business, i.e., cash sale 2) sale of services rather than commodities. Hence they do not maintain big inventories and therefore, probably have the least requirement of WC. Trading(Adani enterprises, Bombay cycle) and financial enterprises- Sharekhan, Indiabulls Capital etc. The nature of their business is such that they have to maintain a sufficient amount of cash, inventories and book debts. Hence they have to invest large amounts in WC. Manufacturing enterprises-HAL, BHEL Under manufacturing enterprises some of the industries require large amounts of WC. It varies from industry to industry depending on their asset structure
- Production cycle Refers to the time involved in the manufacture of goods. It covers the time span between the procurement of raw materials and the completion of manufacturing process leading to the production of finished goods Naturally there is some gap before raw materials become finished goods. To sustain such activities the need for wc is obvious The longer the time span/production cycle, the larger the working capital requirement For example, a distillery, which has an ageing process has to make a heavy investment in inventory and hence working capital requirement is high Bakeries, which sell their products at short intervals have a high inventory turnover and hence working capital is not very large
- w.r.t business cycle(cycle of expansion and contraction in the economy), Variations in business conditions may be in two directions- Upward phase when boom conditions prevail Downswing phase when economic activity is marked by a decline During boom conditions, the need for working capital is likely to grow to cover the lag between increased sales and receipt of cash as well as to finance the purchases of additional material to cater to the expansion of level of activity. Additional funds may be required to invest in plant and machinery to meet increased demand The downswing phase will have an exactly opposite effect on working capital requirement. The decline in the economy is associated with a fall in the volume of sales which in turn will lead to a fall in the level of inventories and book debts
- For certain lines of business, demand for products is seasonal, i.e., they will be purchased during certain months of the year. Such businesses can either confine their production only to periods when goods are purchased or they can follow a steady production policy throughout the year and produce goods at a level to meet the peak demand In the first case, there will be serious production problems, it will have to operate at full capacity to meet the demand, whereas in the slack season the firm will have to maintain its working force and physical facilities without adequate production and sale This kind of arrangement would not only be expensive but also inconvenient A better alternative would be a steady production policy independent of shifts in demand for the finished goods This will mean large accumulation of finished goods during off season and abrupt sale during peak season. The progressive accumulation of stock will naturally require an increasing amount of wc.
- Credit policy influences the requirement of working capital in two ways Through credit terms granted by the firm to its customers Credit terms available to the firm from its creditors The credit terms granted to customers have a bearing on the magnitude of wc by determining the level of book debts. Credit sales will result in higher book debts, which in turn will mean more working capital If liberal credit terms are available from suppliers of goods, the need for working capital will be less
- It is logical to expect that as a company grows larger amount of wc will be required When a company a grows it has to meet higher production and sales target and hence has to maintain a good amount of inventory and would require more wc than those companies that are static The critical fact is that, the need for increased wc funds does not follow the growth in business activities, but precedes it
- Higher profit margin would improve the prospects of generating more internal funds thereby contributing to working capital pool Payment of dividend consumes cash resources and hence affects wc to some extent
- Price rise does not have uniform effect on all commodities and types of firms. For ex, increase in bus fares may not have a huge impact on the working capital position. So it varies from company to company depending on nature of its operations, its standing in the market and so on
- Management has a discretion over the wc position Mgmt cannot control rise in prices but can ensure efficient utilisation of resource by eliminating waste, improving coordination and fuller utilisation of existing resources. This leads to increased profitability and in turn as discussed earlier under profit level, improve wc turnover