What are factors determining working capital requirements in business?

Ans: The factors determining working capital needs of a business firm are as follows: 1. Size of the firm: A large firm needs more working capital than a small firm. In order to sustain the high volume of production and sales, a large firm has to maintain greater current assets. 2. Nature of Business: A trading concern has to maintain more inventory than a manufacturing concern. Therefore, more working capital is required by a trading concern. Public utility concerns such as railways, electricity supply concerns, gas agencies require less working capital because most of their transactions are on cash basis. Similarly, hotels and restaurants need little working capital as stock and debtors are not high. 3. Type of Production Process: A firm using labour intensive technique needs more working capital to pay wages and salaries. A highly automatic plant will need less working capital and more fixed capital. Working capital requirements are higher when raw materials account for a major proportion of the total cost. 4. Length of Operating Cycle: Longer is the time gap between purchase of raw materials and receipt of cash from debtors, greater is the need for working capital. That is why firms having a lengthy and roundabout manufacturing process require more working capital. For example, a heavy engineering firm has a longer operating cycle than a rice mill. 5. Inventory Turnover: Where the inventory is large and its turnover is slow, working capital required is more. Inventory turnover means the speed with which sales are made. For example, a jeweller has to maintain a high inventory of different types of jewellery and the movement of inventory is slow. Therefore, the working capital requirements of a jeweller are more than those of a grocer. 6. Terms of Credit: An enterprise with a liberal credit policy require more working capital. Such a firm allows credit to all its customers, the period of credit is comparatively long and

debts are hot collected strictly within the credit period. Similarly, a concern enjoying liberal credit from the suppliers need less working capital. 7. Banking facilities: Where good, quick and dependable credit is available from commercial banks, a concern can manage its operations with relatively less working capital. In such a case, cash requirements are small. 8. Seasonal variations: Some enterprises need greater working capital during particular seasons. For example, a sugar mill requires more working capital during December to April when production takes place. It requires much less working capital in other months. 9. Contingencies: If the demand for and prices of products of a small enterprise are subject to wide and unexpected fluctuations, provision has to be made for arranging higher amounts of working. capital. Trade cycles may affect the amount of working capital required in an enterprise. 10. Terms of purchase and sale: If the firm purchases raw materials and other needs on credit and sells on cash basis, it requires less working capital. If it buys on cash basis and sells its product on credit, it will need a large amount of working capital because of instant payments and slow collections. 11. Importance of labour: If project is labour intensive, large amount of working capital is required.

Determination Of Working Capital Determination of working capital requirement is one of the major short-term planning which plays very vital role for operating the business successfully. The determination of working capital is to be done very effectively otherwise there may be over or under estimation of working capital. The amount of working capital should be sufficient. Following two methods can used to determine the amount of working capital:

1. Projected Balance Sheet Method 2. Operating Cycle Method 1. Projected Balance Sheet Method It is the conventional method of calculating working capital. Total current assets and current liabilities are taken into account to calculating working capital. All the data given in balance sheet regarding current assets and current liabilities are taken into consideration for estimating the working capital. Total current liabilities is deducted from total current assets to obtain the amount of net working capital under this method. Net Working Capital = Total Current Assets - Total Current Liabilities 2. Operating Cycle Method Time which is needed to convert raw material into finished goods, finished goods into sales and account receivable into cash is called operating cycle. Under operating cycle method, time needed for different types of current assets and time lag needed for payment of purchase and expenses are considered to compute requirement of working capital. The items of current assets and current liabilities are calculated as follows: * Raw material inventory = (Annual output x material cost per unit x inventory holding period)/Total Periods * Work-in-progress Inventory = (Annual output x Manufacturing cost per unit x Inventory holding period)/Total periods

* Finished Goods Inventory = (Annual output x total cost per unit x inventory holding period)/Total periods * Account Receivable(Debtors) = ( Annual credit sales units x total cost per unit x credit period allowed)/Total periods * Prepaid Expenses = (Annual Expenses x Advance Period)/Total periods * Account Payable (Creditors) = (Annual output x raw material cost per unit x credit period)/Total periods * Outstanding Wages = (Annual output x labor cost per unit x time lag)/ Total periods * Outstanding Overhead = (Annual output x overhead per unit x time lag)/Total periods * Outstanding Expenses ( Annual expenses x Time lag)/ Total periods