What is working capital? How is it calculated?

CBSE Class 12 CBSE Class 12 Business Studies
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1

What is working capital? How is it calculated? Discuss five important determinants of working capital requirement.
or
Explain any four factors affecting the ‘working capital requirements’ of a company.
or
You are the financial manager of a newly established company. The directors have asked you to determine the amount of working capital requirement for the company. Explain any four factors that you will consider while determining the working capital requirement for the company.Z

2

Calculation of working capital Working capital, unless otherwise specified is the net working capital. Net working capital is the excess of current assets over current liabilities. Thus, Net Working Capital = Current Assets - Current Liabilities or
NWC = CA - CL
Factors affecting working capital:

  1. Nature of Business
    The basic nature of a business influences the amount of working capital. A trading organisation and a service industry firm usually needs a smaller amount of working capital as compared to a manufacturing organisation. -
  2. Scale of Operations
    Organisations which operate on a large scale, their quantum of inventory and debtors required is generally high. Such organisations, therefore, require large amount of working capital as compared to the organisations which operate on a lower scale.
  3. Business Cycle
    Different phases of business cycles affect the requirement of working capital by a firm. In case of a boom, the sales as well as production are likely to be larger and, therefore, larger amount of working capital is required. As against this, the requirement for working capital will be lower during the period of depression, since the sales as well as production will be less.
  4. Seasonal Factors
    Some of the businesses have seasonal operations. During peak season, larger amount of working capital is required because of higher level of activity.
    As against this, the level of activity as well as the requirement for working capital will be lower during the lean season.
  5. Production Cycle/Operating Cycle
    Production cycle is the time span between the receipt of raw material and their conversion into finished goods. 4
    Some businesses have a longer production cycle while some have a shorter one. Duration and the length of production cycle affect the amount of funds required for raw materials and expenses.
  6. Credit Allowed '
    Different firms allow different credit terms to their customers. These depend upon the level of competition that a firm faces, as well as the credit worthiness of their clientele.
    A liberal credit policy results in higher amount of debtors, increasing the requirement of working capital.
  7. Credit Availed
    Just as a firm allows credit to its customers, it also may get credit from its suppliers. To the extent, it avails the credit on purchase, the working capital requirement is reduced.
  8. Availability of Raw Materials
    If the raw materials are easily and readily available, lower stocks will have to be maintained. Whereas, ,
    when the raw materials are scarce or not readily available, higher stock levels have to maintained, thus increasing the need for working capital requirement.
  9. Time Lag
    It is also known as lead time and is an important factor as to how much working capital is required. Time lag is the time taken between the placement of order and actual receipt of material.
    If the time lag is more, more working capital will be required, as larger amount of materials will have to be stored.