8 Factors that Determine the Requirements of Working Capital

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8 Factors that Determine the Requirements of Working Capital

Every business enterprise, irrespective of its size, requires adequate working capital to keep running day-to-day operations smoothly. Lower working capital always results in lower business efficiency and market competitiveness. Many business enterprises fail in the market due to poor working capital management. 

There are multiple factors influencing working capital requirements in a business, and they vary from business to business. The following are the top eight factors affecting working capital that are common in every business:

1. Sales

For any business, the size of the sale matters. To have a higher sales number, the business needs to maintain higher current assets in the form of inventory and cash at hand to sustain the operations and fulfill demand. Therefore, a business with a higher sales number requires higher regular working capital compared to a business with a lower sales turnover.

2. Length of the Operating Cycle

The operating cycle refers to the number of days it requires to acquire inventory, sell the inventory, and collect cash from the sale of inventory. A business with a longer operating cycle will have higher working capital requirements compared to a shorter operating cycle. For example, a chips manufacturer will have a shorter operating cycle compared to a real estate developer.

3. Inventory Management Policy

The working capital requirement also depends on the inventory management policy of the company. For example, if a company wants to stock all the raw materials before starting production, the working capital requirement will be very high as resources will get stuck until the operating cycle completes. But, if the company follows the Just in Time (JIT) inventory management policy, where materials are sourced just before the need arises, the working capital requirement will be much lower.

4. Size of Business

The working capital requirements go up with the growth in the size of the business and scale of operations. A company that operates on a large scale with multiple manufacturing units spread across different regions will have higher working capital needs but will have better economics due to better bargaining power compared to small business units.

5. Credit Policy

The credit policy also dictates the working capital requirements of the business. A small business has to depend on deferred payments to drive sales and secure business orders. In case of missed payments from clients, it hurts the working capital requirements. Also, if you have raised any working capital loan in the past or have any short-term liabilities, its repayment will add to the working capital costs.

Naturally, in such a case working capital requirements will be higher. If supplies of raw materials are available on favorable terms and there are timely payments from clients, the requirement for working capital will be much less.

Must Read: What are the Different Types of Working Capital?

6. Seasonality of Business

Many businesses don’t generate enough sales throughout the year and are only season-specific. For example, businesses dealing in woolen garments, tourism industry, seasonal fruits exporters, etc. Such businesses experience a quick upsurge in sales that lasts a few weeks to months. During such a period, the business will require higher working capital requirements compared to the rest of the year to ensure competitiveness in the market.

7. Nature of Production Technologies

The nature of production technology incorporated in plants also impacts working capital needs. For example, if a plant uses a labor-intensive manufacturing process, the cost of wages will be higher compared to those plants that use automated production processes. A plant with an automated production process will require fewer workers, therefore the expenses like wages will be lower and there will be less wastage of resources, resulting in lower working capital requirements.

8. Contingencies

Risks in business also impact operational efficiency and working capital needs. Factors like inflation, and reduced demand due to changing trends in the market, impact the working capital requirements. All such factors increase the working capital requirement and the business needs to increase the contingency provisions to keep the business operations running.

Conclusion:

Depending on the nature of the business and other factors, the working capital requirements keep on changing. Therefore, the business needs a robust working capital management strategy so that the company operates efficiently using its current assets and current liabilities. 

If there are any shortages, you can consider applying for a working capital loan with your lender. It will help you to maintain accounts payable, make short-term inventory purchases, and meet other short-term financial requirements. 

Before applying for a working capital loan, check your eligibility using the business loan eligibility calculator to have an improved chance of loan approval. Also, you can use the business loan calculator to know the repayment structure and plan the size of the total working capital loan you can afford as per your business financials and cash flow.