Working capital is that part of total capital that is required to meet day-to-day expenses, to buy raw materials, to pay wages and other expenses of routine nature in the production process or we can say it refers to excess of current assets over current liabilities.
Working Capital = Current Assets – Current Liabilities
Factors affecting working capital requirements are. the following :
1. Nature of business: The basic nature of a business influences the amount of working capital required. A trading organization usually needs a lower amount of working capital compared to a manufacturing organization. This is because, in trading, there is no processing required. In a manufacturing business, however, raw materials need to be converted into finished goods, which increases the expenditure on raw material, labour and other expenses.
2. Scale of operation: For firms which are operating on a higher scale of operations, the quantum of inventory, debtors required is generally high. Such organizations, therefore, require large amount of working capital as compared to the organizations which operate on a lower scale.
3. Production Cycle: Production cycle is the time span between the receipts of raw materials and their conversion into finished goods. Some businesses have a longer production cycle while some have a shorter one. Working capital requirement is higher in firms with longer processing cycle and lowers in firms with shorter processing cycle.
4. Credit Allowed: Different firms allow different credit terms to their customers. A *** credit policy results in a higher amount of debtors, increasing the requirements of working capital.
5. Credit Availed: Just as a firm allows credit to its customers it also may get credit from its suppliers. The more credit a firm avails on its purchases, the working capital requirement is reduced.
