Working Capital Management

Need for Working Capital:

The need for working capital cannot be over emphasized. Every business needs some amount of working capital. The need for working capital arises due to the time gap between production and realization of cash from sales. There is an operating cycle involved in the sales and realization of cash.

Thus working capital is needed for the following purposes:

• For the purchase of raw materials, components and spares.
• To pay wages and salaries.
• To incur day-to-day expenses and overhead costs such as fuel, power and office, etc.
• To meet the selling costs as packing, advertising, etc.
• To provide credit facilities to the customers.
• To maintain the inventories of raw material, work-in-progress, stores and spares and finished stock.

Factors affecting the composition of Working Capital:

The following are the some of the significant factors affecting the composition of working capital:

• Nature and Size of Business: Trading and financial firms require large working capital while public utilities require limited working capital. A firm with larger scale of operations will need more working capital than a small firm.
• Production Cycle: Production cycle refers to the time involved in the manufacture of goods, i.e., time span between the procurement of raw materials and the completion of manufacturing process. The longer the time span, the larger will be the tied up funds, so larger working capital needed and vice versa.
• Business Cycle: Business fluctuation leads to cyclical and seasonal changes, which in turn, causes a shift in the working capital. During upward phase working capital requirements is more and is less during downward phase.
• Production Policy: The requirement of working capital is more in case of maintaining a constant production schedule while working capital requirement is less in case of the firm which adopted production schedule in accordance with the change in demand.
• Firm’s Credit Policy: A firm will need less working capital if liberal credit terms are available to it from creditors. Similarly, the firm will need more working capital if they adopted liberal credit policy to their debtors.
• Degree of Competition in the market: When the degree of competition in the market for finished goods in an industry is high, then companies belonging to the industry may have to resort to an increased credit period to its customers, thereby increasing accounts receivables.

Working Capital Cycle:

In a manufacturing concern, the working capital cycle starts with the purchase of raw materials and ends with the realization of cash from the sale of finished products.

This cycle involves purchase of raw materials and stores, its conversion into stocks of finished goods through work-in-progress with progressive increment of labour and service costs, conversion of finished stock into sales, debtors and receivables and ultimately realization of cash and this cycle continues again from cash to purchase of raw materials and so on.