The working capital needs of a firm are influenced by numerous factors. The important ones are:
1. Nature of business
2. Seasonality of operations
3. Production conditions
4. Market conditions
5. Conditions of supply
Nature of business: The working capital requirement of a firm is closely related to the nature of its business. A service firm, like an electricity undertaking or a transport corporation, which has a short operating cycle and which sells predominantly on cash basis, has a modest working capital requirement. On the other hand, a manufacturing concern like a machine tools unit, which has a long operating cycle and which sells largely on credit, has a very substantial working capital requirement.
Seasonality of Operations: Firms which have marketed seasonally in their operations usually have highly fluctuating working capital requirements. To illustrate, consider a firm manufacturing ceiling fans. The sale of ceiling fans reaches a peak during the summer months and drops sharply during the winter period. The working capital need of such a firm is likely to increase considerably in summer months and decrease significantly during the winter months. Electric bulbs, tubes and CFL lamps have fairly even sales round the year, tends to have stable working capital needs.
Production Policy: A firm marketed by pronounced seasonal fluctuations in its sales may pursue a production policy which may reduce the sharp variations in working capital requirements. For example, a manufacturer of ceiling fans may maintain a steady production throughout the year rather than intensify the production activity during the peak business season. Such a production policy may dampen the fluctuations in working capital requirements.
Market conditions: The degree of competition prevailing in the market-place has an important bearing on working capital needs. When competition is intense, a larger inventory of finished goods is required to promptly serve customers who may be inclined to wait because other manufacturers are ready to meet their needs. Further, generous credit terms may have to be offered to attract customers in a highly competitive market. Thus, working capital needs tend it be high because of greater investment in finished goods inventory and accounts receivable.
If the market is strong and competition is weak, a firm can manage with smaller inventory of finished goods, because customers can be supplied with some delay. Further, in such a situation the firm can insist on cash payment and avoid lock-up of funds in accounts receivable – it can even ask for advance, partial or total.
Conditions of Supply: The inventory of raw materials, spares and stores depends on the conditions of supply. If the supply is prompt and adequate, the firm can manage with small inventory. However, if the supply is unpredictable and scant, then the firm, to ensure continuity of production would have to acquire stocks as and when they are available and carry larger inventory on an average. A similar policy may have to be followed when the raw material is available only seasonally and production operations are carried out round the year.
Working Capital Policy:
Two important issues in working capital policy are:
1. What should be the level of investment in current assets?
2. What mix of long term, financing and short term financing should the firm employ to support current assets?
Level of Current Assets:
Under a flexible policy (also referred to as a conservative policy) the investment in current assets will be high. This means that the firm maintains a huge balance of cash and marketable securities carries large amount of inventories, and gas generous terms of credit to customers which leads to a high level of debtors. Under a restrictive policy (also referred to as aggressive policy) the investment in current assets is low. This means that the firm keeps a small balance of cash and marketable securities, with small amounts of inventories and offers stiff terms of credit which leaders to a low level of debtors.