What are the Determinants of Working Capital?

Working Capital management involves the relationship between a firm’s short term assets and its short term liabilities. The determinants of working capital are:

1. Nature of business
   • One of the main factors
   • Usually trading business requires higher WC as most of the investment is in stock or inventory. 
   • Manufacturing firms also requires high WC to meet operational expenses. 
   • Services firms requires relatively less WC. 
2. Size of business
   • As size increases, the WC requirement also increases and vice versa.
3. Credit terms/Credit policy
   • Credit terms generally influence WC needs. 
     • Buy on credit and sell on cash – lower WC
     • Buy on credit and sell on credit – medium WC
     • Buy on cash and sell on cash – medium WC
     • Buy on cash and sell on credit – higher WC
   • Credit policy – Influenced by trade practices and economic condition
     • A liberal credit policy results in more trade debtors. 
     • Credit periods – longer credit period is allowed to the debtors as against the one extended to the firm by its creditors, more WC is needed and vice versa. 
     • Collection policy – a stringent collection policy results in lower requirement of WC and vice versa. 
     • Collection procedure – decentralized collection of dues and centralized payments to the creditors shall reduce the size of WC, centralized collection and centralized payments result in moderate level of WC and centralized collection and decentralized payments results in high WC requirement. 
4. Seasonality
   1. Seasonality of production – During seasons, when production activities are in peak, WC need is high. 
   2. Seasonality in supply of raw materials – High level of WC is needed when season exists for raw materials. 
   3. Seasonality of demand for finished goods – Need to run the process throughout the year to meet the seasonal demands – hence WC requirement will be higher. 
5. Trade cycle – periodic turns in business opportunities. 
   • Boom period – more business, more production, more WC.
   • Depression period – less business, less production, less WC
   • Recession period – reduced business, stock pile-up, more WC
   • Recovery period – recouping business, stock speedily converts to sale, less WC. 
6. Inflation – Rising prices, reduced demand, results in stock pile up and results in increased WC requirement.
7. Production cycle – longer production process, higher volume and value of work in progress results in higher WC requirement and vice versa. 
8. System of production process
   • Capital intensive – high technology, automated systems – less investment in current assets and more investments in fixed assets – results in less WC needs. Also conversion time is less, resulting in further reduction in WC needs. 
   • Labour intensive – less investment in fixed assets and more investment in current assets lead to higher requirement of WC.
9. Growth and expansion plans – higher WC.