What is a working capital? How is it calculated? Discuss five important determinants of working capital requirement.
Answers
SOLUTION :
Working capital :
Excess of current assets over current liabilities is known as working capital. Working capital is required to meet day to day finance requirements of production and distribution of a business.
Working capital = current assets - current liabilities
The five important determinants of working capital requirement are:
(a) NATURE OF BUSINESS :
Nature of business is divided into two categories one is trading business firms and other is manufacturing firms.
Trading firm deals in readymade finished goods, so it requires less amount of working capital. Manufacturing firm requires higher amount of working capital to be invested in the goods.
(b) SCALE OF OPERATION :
An organisation operating at a higher scale of operation requires a large amount of working capital where as an organisation operating at a small scale requires lesser amount of working capital.
(c) LENGTH OF BUSINESS CYCLE :
Longer production cycle means higher amount of funds are required for material and other expenses, so higher amount of working capital will be required. Shorter the period of production would require low amount of working capital.
(d) SEASONAL FACTORS :
During peak season larger amounts of working capital is required because of the requirement of higher level of inventory. During lean period the sale is low and requirement of working capital is also low.
(e) PRODUCTION CYCLE :
Businesses with longer production cycle require more working capital as there is long time gap between the recipient of raw materials and their conversion into finished goods and vice versa.
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Answer:
Explanation:
An organisation operating at a higher scale of operation requires a large amount of working capital where as an organisation operating at a small scale requires lesser amount of working capital.