Factors Determining Cash needs
The working capital needs of a firm are influenced by numerous factors. The important ones are:
- Nature of business.
- Seasonality of operations.
- Production policy.
- Market conditions.
- Conditions of supply.
Nature of business:
The working capital requirement of a firm is closely related to the nature of its business. A service firm, like an electricity undertaking or a transport corporation which has a short operating cycle and which sells predominantly on cash basis, has a modest working capital requirement. On the other hand, a manufacturing concern likes a machine tools unit, which has a long operating cycle and which sells largely on credit, has a very substantial working capital requirement.
Seasonality of operations:
Firms which have marked seasonality in their operations usually have highly fluctuating working capital requirements. To illustrate, consider a firm manufacturing ceiling fans. The sale of ceiling fans reaches a peak during the summer months and drops sharply during the winter period. The working capital need of such firm is likely to increase considerably in summer months and decrease significantly during the winter period. On the other hand, a firm manufacturing product like lamps, which have even sales round the year, tends to have stable working capital needs.
A firm marked by pronounced seasonal fluctuation in its sales may pursue a production policy which may reduce the sharp variations in working capital requirements. For example, a manufacturer of ceiling fans may maintain a steady production throughout the year rather than intensify the production activity during the peak business season. Such a production policy may dampen the fluctuations in working capital requirements.
The degree of competition prevailing in the market has an important bearing on working capital needs. When competition is keen, a larger inventory of finished is required to promptly serve customers who may not be inclined to wait because other manufacturers are ready to meet their needs.
Further, generous credit terms may have to be offered to attract customers in a highly competitive market. Thus, working capital needs tend to be high because of greater investment in finished goods inventory and accounts receivable.
If the market is strong and competition weak, a firm can manage with a smaller inventory of finished goods because customers can be served with some delay. Further, in such a situation the firm can insist on cash payment and avoid lock-ups of funds in accounts receivable –it can even ask for advance payment, partial or total.
Conditions of supply:
The inventory of raw materials, spares, and stores on the conditions of supply. If the supply is prompt and adequate, the firm can manage with small inventory. However, if the supply is unpredictable and scant, then the firm, to ensure continuity of production, would have to acquire stocks as and when they are available and carry large inventory on an average. A similar policy may have to be followed when the raw material is available only seasonally and production operations are carried out round the year.