Question

Question 5: Capital is an important aspect in any business. Capital is a financial assets, such as funds held in deposit accounts and/or funds obtained from special financing sources. Capital can also be associated with capital assets of a company that requires significant amounts of capital to finance or expand. As accountant of Alfa wan company, it is your basic role to decide the working capital of your company. what are the points you keep in mind while deciding the working capital of company? elaborate any ten points. and suggest five points which are suitable to have adequate working capital.

( write up to 200 word)

Answer 1

Working Capital is basically an indicator of the short-term financial position of an organization and is also a measure of its overall efficiency. Working Capital is obtained by subtracting the current liabilities from the current assets. This ratio indicates whether the company possesses sufficient assets to cover its short-term debt.
The firm must estimate its working capital very accurately because excessive working capital results in unnecessary accumulation of inventory and wastage of capital whereas shortage of working capital affects the smooth flow of operating cycle and business fails to meet its commitment. Basically the following points should be kept in mind while deciding the working capital of company.

1. Length of Operating Cycle:

Operating cycle refers to the time period involved in production. If operating cycle of a business is long, more working capital is required. If it is short, the working capital requirement is less.

2. Nature of Business:
In case of trading concern or retail shop the requirement of working capital is less because length of operating cycle is small. The manufacturing company requires huge amount of working capital.

3. Scale of Operation:
The firms operating at large scale need to maintain more inventory, debtors, etc. So they generally require large working capital whereas firms operating at small scale require less working capital.

4. Business Cycle Fluctuation:
During boom period the market is flourishing so more amount of working capital is required. Whereas during depression period less working capital will be required.

5. Seasonal Factors:
The working capital requirement is constant for the companies which are selling goods throughout the season whereas the companies which are selling seasonal goods require huge amount of working capital during their season.

6. Technology and Production Cycle:
If a company is using labour intensive technique of production then more working capital is required for making payments to labour whereas if company is using machine-intensive technique of production then less working capital is required.

7. Operating Efficiency:
The firm having high degree of operating efficiency requires less amount of working capital as compared to firm having low degree of efficiency which requires more working capital.

8. Availability of Raw Materials:
If raw materials are easily available, then firms can manage with less amount of working capital. If the supply of raw materials is not smooth then, the firms require more working capital.

9. Level of Competition:
If the market is competitive then company will have to adopt liberal credit policy and to supply goods on time. Higher inventories have to be maintained so more working capital is required. A business with less competition or with monopoly position will require less working capital as it can dictate terms according to its own requirements.

10. Growth Prospects:
Firms planning to expand their activities will require more amount of working capital as for expansion they need to increase scale of production.

5 suggestions to have adequate working capital.

1. Manitain proper accounts receivable. Give incentives to customers who pay on time. Do not transact business with customers who have a history of defaulting.
2. Meet the debt obligations on time. Avoid the situations that delay payments and causing penalties.
3. Maintain proper inventory management system. Do not overstock the inventory.
4. Reduce fixed and variable costs, which will give more liquidity for working capital.
5. Keep up to date financial information for decision making. Keep financial records current and calculate current ratios and quick ratios frequently.