Factors affecting composition of working capital, Financial Management

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Posted Date: 2/14/2013 1:20:17 AM | Location : United States

The factors that are affecting the Composition of Working Capital are:-

1.   Nature of Business
Various companies operating in different Industries have different Working Capital needs. A purely Trading Organization will mainly have finished goods Inventory, Accounts Receivable and Cash as Current Assets and Accounts Payable like Current Liability. Alternatively, Capital Goods manufacturing and Trading Companies will have a high proportion of Current Assets in the form of inventory of Raw Materials and Work-in-Progress. So, the nature of Business is directly related to the requirement of Working Capital.

2.   Nature of Raw Material Used
The nature of Raw Material utilized in the manufacture of finished goods greatly influences the quantum of Raw Material Inventory. For instance, 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.
Likewise 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 requirement for whose product is growing over time, the trend will be to contain high Inventory of Raw Material and Components.

3.   Process Technology Used
In case the Raw Material has to undergo several stages during the process of production, the Work-in-Progress Inventory is similarly to be much higher than any other item of the Current Assets thereby increasing the requirement of Working Capital.

4.   Nature of Finished Goods
The nature of Finished Goods greatly influences the amount of finished goods inventory. For instance, if the finished goods have a short span of ''shelf-life'' as in the case of cigarettes the finished goods inventory will constitute an extremely low percentage of current assets.
In the case of organizations the demand for whose finished goods is seasonal in nature, as in the case of fans, the inventory of finished goods will comprise a high percentage of total current assets. This is mostly because from the point of view of the fixed costs to be incurred by the company it would be much more economical to maintain an optimum level of production during the year than by stepping up production operations during the busy season.

5.   Degree of Competition in the Market
While the Degree of Competition in the market for finished goods in an industry is high as compared to companies belonging to the Industry may have to resort to an increased credit period to its customers, partially lowering credit standards and identical other practices to push their products. These practices are probable to result in a high proportion for Accounts Receivables thereby increasing the requirement for Working Capital.

6.   Growth and Expansion
As the company grows, it is logical to suppose that a larger amount of working capital is required. It is, of course, tricky to find out precisely the relationship among the growth in volume of business of a company and the raise in the working capital. The composition of working capital as well shifts with economic circumstances and corporate practices. Other things being equal, growth Industries need more working capital than those that are static. The Critical fact however, is that the requirement for increased working capital funds does not follow the growth in business activities but precedes it. Advance planning of working capital, is hence a continuing necessity for a growing concern.

Posted by Bony | Posted Date: 2/14/2013 1:23:30 AM

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