Understand the Factors that Affect Your Working Capital Needs

Working capital is a crucial need for businesses of all kinds and levels. The way you use it will affect your profit margins and its efficient management will help you to draw higher returns from your fixed assets.

Before we look deeper into this concept, let us check the mathematical formula for computing working capital

Working Capital = Current Assets – Current Liabilities

A company that has more of current assets - such as cash, cash equivalents, account receivables, inventory and short term deposits - over current liabilities like accounts payable, taxes payable and interest payable, can use its positive working capital to keep going with normal operations.

In a way, working capital is the total of business’s short term liquidity and it is vital for financial analysis and management of cash flow. We will now look into the top factors that impact working capital management (WCM) for a business:

The Industry

Working capital needs vary from one industry to another. In service segment with travel agencies, utilities, repair solutions, and to some extent hotels, there the owners need not invest heavily in inventory. One major part of working capital is not applicable here. However in manufacturing concerns, companies must invest in both fixed and current assets. The way they manage their working capital will therefore be different.

Size of business unit

You may have obtained a limited liability partnership registration for your company or got it registered as sole proprietorship, it is the size of unit and initial investment level that will affect your WCM.

Seasonality of business

If the demand for a business’s products is seasonal, it will have fluctuating working capital needs. Examples can be cited in terms of air conditioner sellers and sweater manufacturers. In India ACs are usually bought between April and August whereas the sales of woollens pick up from November and lasts till early February. Businesses that see such seasonal variations in their sales must strategise their production policy to minimise the variations in their working capital requirements. This can be achieved by producing moderately throughout the year and launching schemes for off-season sales.

Nature of competition

Another factor that impacts WCM is the degree of competition faced by the business. If this is intense, the participating businesses will keep larger inventories of finished goods to keep fulfilling customer demands. However products with short shelf life will need to be maintained in small numbers even if the competition is vigorous. In this case business owners need to manage their supply chain more efficiently to regulate WCM.

Manufacturing cycle and technological impacts

The time it takes from processing of raw materials to get final saleable products is the manufacturing cycle of a business. If this is a long process, funds will remain stuck for that long in working capital. For a similar production level, labour intensive techniques call for higher investment in current assets than technologically intensive processes. This is another factor affecting WCM.

To manage your funds and keep business operations profitable, focus on factors that concern your organisation. For further assistance, contact professional business consultants.

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