Definition of Working Capital

Current assets minus current liabilities. Working capital measures how much in liquid
assets a company has available to build its business. The number can be positive or
negative, depending on how much debt the company is carrying. In general, companies
that have a lot of working capital will be more successful since they can expand and
improve their operations. Companies with negative working capital may lack the funds
necessary for growth also called net current assets or current capital.

Q- FACTORS WHICH DETERMINAN THE WORKING CAPITAL

There are lots of factor of determinants of working capital

1) Nature of business - working capital requirement of a firm basically influenced by the

nature of its business trading and financial forms have a very small investment in fixed
assets, but require a large sum of money to be invested in working capital. Retails stores,
for example must carry large stock of a verity of good to satisfy varied and continuous
demand of their customer.

2) Market and demand condition - the working company related to its sales . it is
difficult to precisely determine the relationship between the volume of sales and working
capital need. Current assets will have to be employed before growth takes place. Then
necessary to make planning of working capital for a growing firm on a continuous basis

3) Technology and manufacturing policy - the manufacturing cycle comprise of the

purchase and use of raw material and the production of finished goods. Longer the
manufacture cycle, larger will be the firm's working capital requirement. For example,
the manufacturing cycle in the case of a boiler, depending on its size, may range between
six to twenty four month. On the other hand the manufacturing cycle of product such as
detergent powder, soap, ice creams etc. may be a few hour extend product take a large
time

4) Credit policy of the firm affect the working capital by influencing the level of debtor.
The credit term to be guaranteed to customer may depend upon the norm of the industry
to which the firm belong. But a firm has the flexibility of shaping its credit policy within
the constraint of industry norms and practice. The firm should use discretion in granting
credit term to us customer

5) Operating efficiency - the operating efficiency of the firm relates to the optimum
utilization of all its resource at minimum costs. The efficiency in controlling operating
cost and utilizing fixed and current assts leads to operating efficiency. The use of
working capital is improved and pace of cash conversion cycle is accelerated with
operating efficiency. Better utilization improves profitability and helps the releasing on
working capital.
3) Business Fluctuations: Business fluctuations are of two types: seasonal fluctuations
which arise out of seasonal changes in demand for the product and cyclical fluctuations
which occur due to ups and downs of economic activities in the country as a whole.

If demand for the product is seasonal, production will have to be increased during the
season, and it will have to be reduced during the off-season. Correspondingly, there will
be fluctuations in the requirement of working capital. The business unit will have to face
some other problems in addition to this one. It has to bear extra expenses to increase
production when product demand increases. It has to bear, costs even to maintain work
force and physical facilities during slack season. For this reason, many units prefer to
continue production even during slack season and increase the level of their inventories.

The cyclical fluctuations are made up of periods of prosperity and depression. The sales
and prices increase during prosperity necessitating more working capital in the form of
inventories and book-debts. If new investment is made in fixed capital to meet additional
demand for the product, then also there will be an increase in working capital
requirement. Generally, business units adopt the policy to borrow funds on a large scale
to increase investment in working capital. As against this, the requirement of working
capital gets reduced during depression and therefore they adopt the policy of reducing
their short term debts.

(4) Production Policy: The production policy of business is also an important

determinant of working capital requirement. If the policy of Constant Production is
adopted, there are two possible effects. If demand for the product is regular and constant,
this policy helps in reducing working capital requirement to the lowest possible level. But
if demand for the product is seasonal, this policy raises the level of inventory during off
season and thereby increases the working capital requirement. If the cost of maintaining
inventory is considerably high, the policy of varying production according to demand is
preferred. If the unit produces varied products, it can reduce the requirement of working
capital by adjusting the structure of production to the changes in demand.

2) Growth and Expansion: The working capital requirements increase with growth and
expansion of business. Hence planning of the working capital requirements and its
procurement must go hand in hand with the planning of the growth and expansion of the
firm. The implementation of the production plan that aims at the growth or expansion of
the unit necessitates more of fixed capital and working capital both.

Even the expansion of the volume of sales increases the requirements of working capital.
Of course, it is difficult to establish a quantitative relationship between them. An
important point to be noted is that the requirements of working capital emerge before the
growth or expansion actually takes place.

(3) Profit and its Distribution: The net profit of a firm is a good index of the resources
available to it to meet its capital requirements. But, from the viewpoint of working capital
requirement, it is the profit in the form of cash which is important, and not the net profit.
The profit available in the form of cash is called cash profit and it can be assessed by
adding or deducting non-cash items from the net profit of the firm. The larger the amount
of cash profit, the greater will be the possibility of acquiring working capital.

But, in fact the entire amount of cash profit may not be available to meet working capital
needs. The portion of cash profit which is available for this purpose depends on the profit
distribution policy. The policies with regard to distribution of dividends, ploughing back
of profit and tax payments will determine the portion of cash profit which the firm can
use to meet its working capital needs. Even depreciation policy can influence the amount
of cash available, as depreciation of capital assets is deductible item of expenditure and it
reduces tax liability.

Nature of Raw Material Used

The nature of Raw Material used in the manufacture of finished goods greatly influences
the quantum of Raw Material Inventory. For example, if the raw Material is an
agricultural product whose availability is pronouncedly seasonal in character, the
proportion of Raw Material Inventory to Finished Goods Inventory will be quite high.
Similarly companies using Imported Raw Materials with long lead time tend to have a
high proportion of Raw Material Inventory. In the case of Capital Goods Manufacturing
Company the demand for whose product is growing over time, the tendency will be to
have high Inventory of Raw Material and Components.