Maintaining a certain proportion of working capital is a crucial aspect of any business. Insufficient working capital can make it challenging for a business to survive and meet their daily needs. Various factors affect the working capital requirement of a business. What are they? Read on to find out!
9 Factors Affecting a Company’s Working Capital
Determination of working capital is a highly significant task, and a company's finance manager considers the factors determining working capital. Here are the factors affecting working capital:
Length of Operating Cycle
The period involved in the production is your operating cycle, and the amount of working capital is directly dependent upon the length of the operating cycle. It begins with acquiring raw materials and ends when payment is received after the sale. More working capital is needed for long operating cycles, whereas companies with short operating cycles require lesser working capital.
Size of Business
The nature and size of the business affect the requirement for working capital. Manufacturing companies require larger amounts of working capital compared to trading companies.
Seasonality of Business
Those business entities selling goods throughout the year have a constant requirement for working capital. On the other hand, the business entities that sell seasonal goods require a large amount during the season since more demand and stock need to be maintained along with the need for fast supply. During the off-season or slack season, these entities require less working capital due to very low demand.
Scale of Operations
The firms that operate at large scale have to maintain more inventory, debtors, etc. Therefore, they usually require huge working capital, whereas firms that operate on a small scale need less working capital.
Sales
The size of sales plays a crucial role in determining working capital. A company needs to keep its current assets in check to boost sales volume. Maintaining a stable ratio of current assets to annual sales results in a higher turnover ratio, reducing the operating cycle duration. A shorter operating cycle requires less working capital, and a longer one demands more.
Competition Level
Adopting a liberal credit policy and delivering goods on time is essential when the market is competitive. Higher inventories need to be maintained, so a large working capital is required. A business with less competition or a monopoly position will need less working capital since it can dictate terms depending on its requirements.
Technology and Production Cycle
Using labour-intensive production technology requires more working capital for paying labour, while machine-intensive production technology needs less as machinery is a fixed cost with lower operational expenses. A longer production cycle demands more working capital due to extended raw material conversion, while a shorter cycle requires less inventory and raw materials investment.
Collection Cycle
The collection period is the average period for the collection of sale proceeds. It depends on numerous factors, including the creditworthiness of clients, industry norms, etc. When a company follows a liberal collection cycle, more working capital will be required. On the other hand, when a company follows a strict or short-term credit policy, less working capital may be sufficient to manage.
Inventory Management
When inventories are large in size, irrespective of the slow turnover, the small-scale business will require more working capital. On the other hand, when inventories are small, the company will require a small amount of working capital, even when their turnover is quick.
Also Read: Boosting Operational Efficiency with Working Capital Finance
What is the Importance of Working Capital Management?
Here’s why working capital management is essential:
- When a company efficiently manages its working capital, it means the owner's money is wisely used, leading to higher profits.
- Businesses with ample working capital can handle financial challenges, preventing shutdowns and losses during crises.
- Well-managed working capital ensures that a company’s assets, like machinery, are used efficiently without unnecessary idleness.
- To grow, a business needs sufficient working capital to manage orders, offer credit to customers, and provide support for overall expansion.
- A balanced working capital management policy reduces interest costs from credit policies, leading to higher profits for the business.
- Efficient working capital management enhances the goodwill of a business and in the end, increases its market value.
What are the Different Types of Working Capital?
The following provides a list of different types of working capital:
- Regular Working Capital
The business requires the capital to perform daily operations like purchasing materials, salaries, wages, etc.
- Permanent Working Capital
It is the minimum capital you need to carry out business operations without any interruptions or difficulties.
- Variable Working Capital
Variable Working Capital is a fluctuating working capital which is invested for a specific time in the company. This capital varies with changes in business sizes or amount of assets. It is divided into two types: Seasonal which is needed during peak seasons, and Special needed for unexpected events.
- Reserve Margin Working Capital
It is the amount of capital which is set aside from working capital for unforeseen circumstances like strikes, natural calamities, etc.
- Gross Working Capital
Gross Working Capital is the total funds in a business's current assets, like cash and inventory. However, it alone doesn't show financial health. To understand efficiency, compare current assets to current liabilities, revealing how well a business uses assets for daily cash needs.
- Net Working Capital
Net Working Capital is the difference between current assets and liabilities. It indicates liquidity, efficiency, and short-term financial health. Adequate working capital enables growth, while insufficient capital raises bankruptcy risks due to difficulties in meeting short-term obligations.
How to Apply for Working Capital?
Now that we have gone through the factors affecting working capital requirements, let’s look at the steps to apply for a working capital loan:
- Step 1: Research and choose a trustworthy lender.
- Step 2: Check eligibility and evaluate the key factors.
- Step 3: Acquire the necessary documents and apply for the loan.
- Step 4: Apply for a Business Loan.
On successful verification of your documents and loan approval, you will get the working capital in your business account.
Also Read: Top 5 Differences between Fixed Capital and Working Capital Loans in Business
To Conclude
Every business organisation finds working capital crucial. The company's finance manager calculates it, considering both internal and external factors affecting working capital. Once the calculation is precise and the requirements are clear, you can apply for the necessary working capital with the required documents. You may even apply for a Business Loan from Poonawalla Fincorp to meet your working capital requirements.
Frequently Asked Questions
1. What are the 4 key components of working capital?
The 4 main components of working capital are – Cash and Cash Equivalents, Accounts Receivable, Inventory, and Accounts Payable.
2. What are the pillars of working capital?
The pillars of working capital include – Inventory management, Receivables Management, and Payables Management.
3. What are the main concepts of working capital?
Quantitative and Qualitative are the two main concepts of working capital.
4. What are working capital and its types?
Working capital refers to the number of current assets exceeding current liabilities. The types of working capital –
- Gross Working Capital
- Net Working Capital
- Permanent Working Capital
- Temporary Working Capital
- Regular Working Capital
- Reserve Margin Working Capital
- Seasonal Working Capital
- Special Working Capital