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DETERMINANTS OF WORKING CAPITAL: The factors influencing the working capital decisions of a firm may be classified as two groups, such as internal factors and external factors. The internal factors includes, nature of business size of business, firm’s product policy, credit policy, dividend policy, and access to money and capital markets, growth and expansion of business etc. The external factors include business fluctuations, changes in the technology, infrastructural facilities, import policy and the taxation policy etc
Internal Factors 1. Nature and size of the business , Firm’s production policy , Firm’s credit policy , Availability of credit , Growth and expansion of business , Profit margin and dividend policy , Operating efficiency of the firm, Co-ordinating activities in firm
II. External Factors 1. Business fluctuations , Changes in the technology,. Import policy , Infrastructural facilities , Taxation policy
MEASUREMENT OF WORKING CAPITAL: There are 3 methods for assessing the working capital requirement as explained below: a) Percent of Sales Method Based on the past experience, some percentage of sales may be taken for determining the quantum of working capital b) Regression Analysis Method The relationship between sales and working capital and its various components may be plotted on Scatter diagram and the average percentage of past 5 years may be ascertained. This average percentage of sales may be taken as working capital. Similar exercise may be carried out at the beginning of the year for assessing the working capital requirement. This method is suitable for simple as well as complex situations. c) Operating Cycle Method: It is also known as working capital cycle. Operating cycle is the total time gap between the purchase of raw material and the receipt from Debtors.
Importance or Advantages of Adequate Working Capital
Working capital is the life blood and nerve centre of a business. Just as circulation of blood
is essential in the human body for maintaining life, working capital is very essential to maintain
the smooth running of a business. No business can run successfully without an adequate amount of
working capital. The main advantages of maintaining adequate amount of working capital are as
follows:
1. Solvency of the business:
Adequate working capital helps in maintaining solvency of the
business by providing uninterrupted flow of production.
2. Goodwill: Sufficient working capital enables a business concern to make prompt payments and
hence helps in creating and maintaining goodwill.
3. Easy loans: A concern having adequate working capital, high solvency and good credit standing
can arrange loans from banks and other on easy and favourable terms.
4. Cash discounts: Adequate working capital also enables a concern to avail cash discounts on the
purchases and hence it reduces costs.
5. Regular supply of raw materials: Sufficient working capital ensures regular supply of raw
materials and continuous production.
6. Regular payment of salaries, wages and other day-to-day commitments: A company which has
ample working capital can make regular payment of salaries, wages and other day-to-day
commitments which raises the morale of its employees, increases their efficiency, reduces
wastages and costs and enhances production and profits
7. Exploitation of favourable market conditions:
Importance or Advantages of Adequate Working Capital
Working capital is the life blood and nerve centre of a business. Just as circulation of blood
is essential in the human body for maintaining life, working capital is very essential to maintain
the smooth running of a business. No business can run successfully without an adequate amount of
working capital. The main advantages of maintaining adequate amount of working capital are as
follows:
1. Solvency of the business: Adequate working capital helps in maintaining solvency of the
business by providing uninterrupted flow of production.
2. Goodwill: Sufficient working capital enables a business concern to make prompt payments and
hence helps in creating and maintaining goodwill.
3. Easy loans: A concern having adequate working capital, high solvency and good credit standing
can arrange loans from banks and other on easy and favourable terms.
4. Cash discounts: Adequate working capital also enables a concern to avail cash discounts on the
purchases and hence it reduces costs.
5. Regular supply of raw materials: Sufficient working capital ensures regular supply of raw
materials and continuous production.
6. Regular payment of salaries, wages and other day-to-day commitments: A company which has
ample working capital can make regular payment of salaries, wages and other day-to-day
commitments which raises the morale of its employees, increases their efficiency, reduces
wastages and costs and enhances production and profits
7. Exploitation of favourable market conditions: Only concerns with adequate working capital can
exploit favourable market conditions such as purchasing its requirements in bulk when the prices
are lower and by
Importance or Advantages of Adequate Working Capital
Working capital is the life blood and nerve centre of a business. Just as circulation of blood
is essential in the human body for maintaining life, working capital is very essential to maintain
the smooth running of a business. No business can run successfully without an adequate amount of
working capital. The main advantages of maintaining adequate amount of working capital are as
follows:
1. Solvency of the business: Adequate working capital helps in maintaining solvency of the
business by providing uninterrupted flow of production.
2. Goodwill: Sufficient working capital enables a business concern to make prompt payments and
hence helps in creating and maintaining goodwill.
3. Easy loans: A concern having adequate working capital, high solvency and good credit standing
can arrange loans from banks and other on easy and favourable terms.
4. Cash discounts: Adequate working capital also enables a concern to avail cash discounts on the
purchases and hence it reduces costs.
5. Regular supply of raw materials: Sufficient working capital ensures regular supply of raw
materials and continuous production.
6. Regular payment of salaries, wages and other day-to-day commitments: A company which has
ample working capital can make regular payment of salaries, wages and other day-to-day
commitments which raises the morale of its employees, increases their efficiency, reduces
wastages and costs and enhances production and profits
7. Exploitation of favourable market conditions: Only concerns with adequate working capital can
exploit favourable market conditions such as purchasing its requirements in bulk when the prices
are lower and by holding its inventories for higher prices. . Ability to face crisis: Adequate working capital enables a concern to face business crisis in
emergencies such as depression because during such periods, generally, there’s much pressure on
working capital.
9. Quick and regular return on investments: Every Investor wants a quick and regular return on his
investments. Sufficiency of working capital enables a concern to pay quick and regular dividends
to its investors as there may not be much pressure to plough back profits. This gains the confidence
of its investors and creates a favourably market to raise additional funds i.e., the future.
10. High morale: Adequacy of working capital creates an environment of security, confidence,
high morale and creates overall efficiency in a business.
Excess or Inadequate Working Capital
Every business concern should have adequate working capital to run its business
operations. It should have neither redundant or excess working capital nor inadequate or shortage
of working capital. Both excess as well as short working capital positions are bad for any business.
However, out of the two, it is the inadequacy of working capital which is more dangerous from the
point of view of the firm.
Disadvantages of Redundant or Excessive Working Capital
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1. Excessive Working Capital means ideal funds which earn no profits for the business and hence
the business cannot earn a proper rate of return on its investments.
2. When there is a redundant working capital, it may lead to unnecessary purchasing and
accumulation of inventories causing more chances of theft, waste and losses
3. Excessive working capital implies excessive debtors and defective credit policy which may
cause higher incidence of bad debts.
4. It may result into overall inefficiency in the organization.
5. When there is excessive working capital, relations with banks and other financial institutions
may not be maintained.
6. Due to low rate of return on investments, the value of shares may also fall.
7.The redundant working capital gives rise to speculative transactions
Disadvantages or Dangers of Inadequate Working Capital
1. A concern which has inadequate working capital cannot pay its short-term liabilities in time.
Thus, it will lose its reputation and shall not be able to get good credit facilities.
2. It cannot buy its requirements in bulk and cannot avail of discounts, etc.
3. It becomes difficult for the firm to exploit favourable market conditions and undertake
profitable projects due to lack of working capital.
4. The firm cannot pay day-to-day expenses of its operations and its creates inefficiencies,
increases costs and reduces the profits of the business.
5. It becomes impossible to utilize efficiently the fixed assets due to non-availability of liquid
funds.
6. The rate of return on investments also falls with the shortage of working capital