Factor affecting working capital

Answer 1

Credit policy. A company tightens its credit policy, which reduces the amount of accounts receivable outstanding. so it frees the cash.

Collection policy. A more aggressive collection policy should result in more rapid collections, which shrinks the total amount of accounts receivable. This is a source of cash.

Inventory planning. A company may elect to increase its inventory levels in order to improve its order fulfillment rate. This will increase the inventory investment, and so uses cash.

Purchasing practices. The purchasing department may decide to reduce its unit costs by purchasing in larger volumes. The larger volumes increase the investment in inventory, which is a use of cash.

Accounts Payable payment period. A company negotiates with its suppliers for longer payment periods. This is a source of cash.

Hedging strategy. If a company actively uses hedging techniques to generate offsetting cash flow, there are less likely to be unexpected changes in working capital.

Answer 2

he working capital needs of a firm are influenced by numerous factors. The important ones are

i) Nature of business: The working capital requirement of a firm is closely related to the nature of business . A service firm , like 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 , 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 .

ii) Seasonality of Operation : Firms which have marked seasonality in there operations usually have highly fluctuating working capital requirement. For example , consider a firm manufacturing air conditioners . The sale of air conditioners reaches the peak during summer months and drops sharply during winter season . The working capital need of such a firm is likely to increase considerably in summer months and decrease significantly during winter period . On the other hand , a firm manufacturing consumer goods like soaps , oil , tooth pastes etc. which have fairly even sale round the year , tends to have a stable working capital need .

iii) Production Policy: A firm marked by pronounced seasonal fluctuation in its sale may pursue a production policy which may reduce the sharp variations in working capital requirements. For example a manufacturer of air conditioners may maintain steady production through out the year rather than intensify the production activity during the peak business season. Such decision may dampen the fluctuations in working capital requirements.

iv) Market Conditions: When competition is keen, larger inventory of finished goods is required to promptly serve the customers who may not 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 highly competitive market . Thus , working capital needs tend to 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 served with delay . Further in such situation the firm can insist on cash payment and avoid lock up of funds in accounts receivables - it can even ask for advance payment , partial or total .

v) Conditions of Supply: The inventory of raw material, spares and stores depends on the conditions of supply. If supply is prompt and adequate, the firm can manage with small inventories. 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 large inventories 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.