Determinants Of Working Capital 5z5825

DETERMINANTS OF WORKING CAPITAL WORKING CAPITAL IS A MEANS AND NOT AN END A company, as matter of policy, does not want to employ large funds in working capital so long as undue solvency risks are not imposed on it. Although no quantitative technique limit of working capital can be set for an individual firm yet adequate amount of amount of working capital can be set for an individual firm yet adequate amount of working capital must be observed to meet the needs of the company. It is logical approach indicating that working capital is a means to an end and not an end itself. The purpose (end) of every business is to run the operation smoothly so that corporate objectives may be achieved and for this purpose adequate working capital is must. The corporate management has to consider various factors in decision-making regarding the quantitative amount of working capital.

FACTORS INFLUENCING WORKING CAPITAL NEEDS :The need of working capital is not always same. It varies from year to year, month to month depending upon a number of factors. There is no set rules or formulas to determine the working capital need of a firm. Each factor has its own importance and the importance of the factors changes for a firm overtime. In order to determine the proper amount of working capital of a concern, the following factors should be considered carefully.

 NATURE OF THE BUSINESS – The amount of working capital is basically related to the nature and volume of the business. In concern where cost of raw material to be used in the manufacturing of a product is very large in proportion to its later cost of manufacture the requirement of working capital will be very large. For instance cotton and sugar mill requires a large amount of working capital. On the contrary, concern having large investments in fixed assets requires less amount of working capital. If it is, public utility concern (such as railway and electricity service) as compared to trading or manufacturing concern require a large amount of working capital partly because of cash nature of their business and partly they are selling a service instead of commodity and, there is therefore no need of maintaining inventories.  SIZE OF THE BUSINESS UNIT – Size of the business unit is also a determining factor in estimating the total amount of working capital. The general principal in this regard is that the bigger size, the larger will be the amount of working capital required as because the large business units are required to maintain big inventories for the flow of the business. Large units have to spend more in carrying out the business operation smoothly.

 SEASONAL VARIATIONS – Strong seasonal movement create certain special problems of working capital in controlling the internal financial swings. A great many companies have to carry on seasonal business such as sugar mills, oil mills, or wooden mills etc, and therefore they require large amount of working capital nearer to the purchase of raw materials in large quantities and utilize them through the year.  TURNOVER OF CIRCULATING CAPITTAL – Turnover means the ratio of annual gross sales to average working assets. In simple words, it means the speed with which circulating capital completes its round or the number of times the amount invested in working assets has been converted in to cash by sale of the finished goods and invested in working assets during a year. The faster the sales, the larger the turnover, conversely the greater the turnover, the larger the volume of business to be done with a given working capital. It will require lesser amount of working capital in spite of large-scale sales because of greater turnover.  LABOUR- Intensive Vs Capital intensive industries- In labour intensive industries , larger working capital is required because of regular payment of heavy wage-bills and more time taken in completing the manufacturing process. Conversely, the capital intensive industries require lesser amount of working capital because of the heavy investment in fixed assets and shorter period in manufacturing.  GROWTH AND EXPANSION OF BUSINESS – Growing concerns requires more working capital than those are static. It is logical to expect large amount of working capital in a growing concern to meet its growing needs of funds.  BUSINESS CYCLE FLACTUATION – At times, when the prices are going up and up, the tendency of management is to pile up a big stock of raw materials and to maintain a big stock of finished goods with an expectation to earn more profits. This condition demands for more and more working capital. The other phase of business cycle i.e. depression involves the looking up of a big amount in the working capital, as the inventories remain unsold and the book debts uncollected. In such cases shortage of working capital develop  PRICE LEVEL CHANGES – The financial manager should also anticipate the effect of price level changes on working capital requirements of the firm. Generally, rising price levels will require a higher amount of working capital.  PROFIT MARGIN AND PROFIT APPROPRIATION – A high level profit margin contributes towards working capital provided it is earned in cash. But in practice, the whole cash inflows are not considered as cash available for sue as cash is used up to augment the other assets such as stock, book debts, and fixed assets. The working capital requirement will be estimated on how cash available is used rightly.

 DIVIDEND POLICY – With a view to maintain an established dividend policy, the management, before declares a dividend, gives due consideration to its effects on cash requirement. If the management follows the policy of retention of profits in the business, the working capital position will be strongly alternative, if the whole of the profits are distributed among the shareholders, company’s working capital position would not be better.

SOURCES OFWORKING CAPITAL:After determining the level of working capital on the basis of various determinants the next step is to consider how it will be financed. A large scale manufacturing concern may procure funds from various sources to meet its working capital requirement from time to time. For the convenience of study, the sources of working capital may be classified under two heads:  Sources of long term or regular working capital  Sources of short term or seasonal working capital.

SOURCES OF LONG TERM OR REGULAR WORKING CAPITALThe long-term working capital requirements include the initial working capital. Various sources for providing long-term working capital requirements are summarised as follows: ISSUE OF SHARES- It is the most important sources of long-term regular working capital. It creates no burden on the fixed charge on the earning assets of the company. ISSUE OF DEBENTURES- By issuing debentures, company may trade on equity in favour of circumstances, but it must be cautions in raising funds by issuing debentures, if there is no stability in the earnings of funds because they create charge on the earning assets of the company. RETAINED PROFITS - Accumulated large profits is also considered to be a good source of financing long-term working capital requirements. It is the best and cheapest way of finance it creates no charge on future profits. TERM LOANS – Mid-term and long-term loans for a period above 3 years provide important source of working capital.

SOURCES OF SHORT-TERM WORKING CAPITAL: Short-term requirements of working capital involve financing day to day business operations. The sources of short-term working capital are as follows: DEPRICIATION FUNDS- Depreciation funds created out of profits of the company provide a good source of working capital provided they are not instead in or represented by an asset.

PROVISION FOR TAXATION- There remains a time lag between making the provision and payment of taxation. A company may utilise such provisions during the intermittent period temporarily. ACCURED EXPENSE - The company sometimes portions the payments of certain expenditures due on the date of finalization of the s. The accrued expenses also constitute an important source of working capital. NORMAL TRADE CREDIT – Trade creditors provide short-term finance to the company by selling the goods, inventories and equipments on the basis of deferred payment. It becomes a very common source of short-term finance and normally every concern use this source as a normal trade practice. CREDIT PAPERS – Under this category, bills payable, promissory notes are included. The occupation of a bill of exchange gets time in making the payment of loan. He may also get finance from his banker by discounting there documents to meet short-term requirements accommodation bill is also an important source of short-term finance.

MEASURING WORKIG CAPITAL Working capital balances are measured through the financial data of corporate balance sheet. Usually, the working capital balance of a going concern has a positive value but often the uses of working capital exceed the source of working capital in certain periods. A study of causes of changes that take place in the balances from time to time is necessary. This involves the basic approach to working capital analysis. Changes in the balances can be measured in rupees and also in percentages by comparing the current assets, current liabilities and working capital over a given period.

RATIO ANALYSIS: Ratio analysis is a powerful tool of working capital measurement that can be used by the management as a means of checking the efficiency with which the working capital is being used in the enterprise. A ratio is defined as the quantitative or the mathematical relationship between two variables. It is the indicated quotient of two mathematical expressions. A ratio helps to summarise large quantities of financial data to make qualitative judgment about the firm’s working capital management. “Ratios are not end in themselves rather on selective basis they may help you to answer significant questions”. “comparison is the essence of the Ratio analysis”.

FUNDS FLOW ANALYSIS: Funds flow analysis is an effective management tool to study how funds have been procured for the business and how they have been employed. The statement of variations in Woking Capital is based fundamentally on the same approach, which is used for preparation of funds flow statement. This technique helps us to analyse changes in Working Capital components

between two dates. The comparison of Current Asset with Current Liabilities as shown in the Balance Sheet at the beginning and the end of the each period shows the changes in the Current Asset, as well as the sources from which Working Capital has been obtained.

WORKING CAPITAL BUDGET: Efficient management of Working Capital involves the careful measurement of future requirements and the formulation of plans for meeting them. The Working Capital budget is an important phase of an overall financial budgeting. The objective of Working Capital budget is to secure an effective utilization of the investments. It is studied by the rate of turnover as measured against sales or cost of goods sold. Scatter charts are used to study the behaviour of Working Capital. This technique can then provide the necessary information for any volume of business.

WORKING CAPITAL CYCLE: Working capital refers to that part of firm’s capital which is required for financing short-term or current asset such as cash marketable securities, debtors, and inventories. Funds thus, invested in current asset keep revolving fast and are being constantly converted into cash and this cash flows out again in exchange for other current asset. Hence it is known as “CIRCULATING CAPITAL”. The circular flow of flow concept is based upon this operating cycle or working capital cycle of a firm. The cycle starts with the purchase of raw materials and ends with the realisation of cash from the sale of the finished goods. It involves purchase of raw material, and stores, its conversion into stock of finished goods through work-in-progress with progressive increment of labour and service cost, conversion of finished stock into sales, debtors and receivables and ultimately realisation of cash and this cycle continues again from cash to purchase of raw material and so on. The speed/ time duration required to complete one cycle determines the requirements of working capital. Longer the period, larger is the requirement of working capital.