Question

What are the factors that influence the working capital needs of a company?

Answer 1

• The size of the company; A big company will be characterized by high levels of assets, sales and activities. Such high levels of assets and sales will call for high levels of working capital to facilitate company’s operations. This will necessitate an increase in cash, stock as well as debtors items of working capital which will be low if the size of the company is small in which case its assets and sales activities will be equally low.

• Nature of the business; A manufacturing firm will be in need of high levels of working capital in form of raw material and may hold high levels  of cash stock and debtors than a trading firm. This, however will depend on the nature of goods manufactured by such a firm.

• Manufacturing  process of a firm; A firm using mechanical manufacturing processes, will  delay the output of such a firm and tie up its cash in such a long manufacturing cycle-thus it may have higher needs of working capital than firms whose manufacturing process are under automation and can sell them and get cash earlier.

• Accessibility to money markets; A firm which has easy access to money markets and even capital markets may not hold too much working capital as it can raise cash easily as and when the need arise. Access to such markets will again depend on factors like size of the firm, its credit rating (worthiness) and nature of the business

• The company's credit policy; The credit terms offered to a company’s customers will determine working capital needs of such a company. A company with a liberal credit policy will extend credit liberally to its customers. This in turn will mean corresponding increase in stock. This will tend to tie up huge amounts of company’s capital hence high levels of working capital. On the other hand, a company with stringent/tight credit policy will give credit to selected customers thus reducing funds that would have otherwise been tied up in debtors and thus stock. Such a company will tend to hold lesser amount of working capital.

These are the factors that influence the working capital needs of a company.