Meaning of Working Capital Raising of Funds Notes of Entrepreneurship
Meaning of Working Capital Raising of Funds Notes of Entrepreneurship :- Hello friends in this post we are provided the materials of the b.com second part its name is fundamental of Business Entrepreneurship notes and its the first chapter of this subject and in this article you learn many more knowledge of Entrepreneurship like as Meaning of working capital, factors affecting the amount of working capital, nature and size of business, business cycle fluctuations, market competitiveness, credit policy, Banking relations, price level changes, other factors, working capital cycle,
Raising of Funds
What do you mean by Working Capital? Describe the factors affecting the amount of Working Capital.
MEANING OF WORKING CAPITAL
Working capital means capital required for day to day working or operations of the enterprise. In other words, working capital is required to meet short-term (usually one year) financial needs of an enterprise. Working capital is required for purchasing raw materials, for payment of wages, salaries, rent, advertisement expenses etc. Working capital is invested in current assets such as cash, debtors, bills receivables, stock of goods or raw materials. Working capital requirements are of short term nature and keep on fluctuating from time to time. It should be remembered that certain minimum amount of working capital is always needed.
FACTORS AFFECTING THE AMOUNT OF WORKING CAPITAL
There is no set of universally applicable rules to ascertain working capital needs of a business organisation. Since, it varies from firm to firm, industry to industry and even in the different seasons of the same firm. Therefore, a large number of factors influence the requirement of working capital, i.e., it depends upon a host of factors. They are discussed here under one by one :
1. Nature and Size of Business : The requirements of working capital of a firm is widely related to the nature and size of the business unit. For example, trading and financial firms require a larÉ6 amount of investment in working capital but a significantly smaller amount of investment in fixed assets. Similarly, a service oriented firm, e.g., transport or electricity generation, needs a modest working capital requirement since it has a very short operating cycle and sales are made on cash basis. But in the case of manufacturing concern which sells its product on credit basis and has a long operating cycle; needs a large amount of working capital. Moreover, the size ofthe firm is also an important factor. Because, a smaller firm needs smaller amount of working capital on the basis of its production activities and vice-versa in the opposite case.
2. Length of Production Cycle : The time taken to convert raw materials into finished products is known as the production cycle. The level of working capital depends upon the production cycle. Longer-the production cycle, more will be the need for working funds in order to finance the current assets during thé prolonged manufacturing cycle. On the other hand, if the production cycle is shorter, the requirements of working capital will also be less.
3. Seasonal Operations : If a firm is operating in goods and services having seasonal fluctuations in demand, then the working capital requirement will also fluctuate with every change. In a cold drink factory, the demand will certainly be higher during summer season and therefore, more working capital is required to maintain higher production, in the form of larger inventories and bigger receivables. On the other hand, if the operations are smooth and even through out the year then the working capital requirement will be constant and will not be affected by the seasonal factors.
4. Business Cycle Fluctuations : Different phases of business cycle, i.e., boom, recession, recovery etc. also affect the
working capital requirement. In case of boom conditions, inflationary pressure appears and business activities expand. As a result, the overall need for cash, inventories etc. increases resultinc in more and more funds blocked in these current assets. In case of recession period however, there is usually a dullness in business activities and there will be an opposite effect on the level of working capital requirement. There will be a fall in inventories and cash requirement etc.
5. Market Competitiveness : The market competitiveness has an important bearing on the working capital needs of a firm. In view of the competitive conditions prevailing in the market, the firm may have to offer liberal credit terms to the customers resulting in higher debtors. Even larger inventories may be maintained to serve an order as and when received, otherwise the customer may go to some other supplier. Thus, the working capital tends to be high as a
result of greater investment in inventories and receivables. On the other hand, a monopolistic firm may not require larger working capital. It may ask the customers to pay in advance or to wait for some time after placing the order.
6. Credit Policy : The credit policy refers the totality of terms and conditions on which goods are sold and purchased. A firm has to interact with two types of credit policies at a time. One, the credit policy of the supplier of raw materials, goods etc., and second, the credit policy relating to credit which it extends to its customers. In both the cases, however, the firm while deciding its credit policy, has to take care of the credit policy of the market. For example, a firm might be purchasing goods and services on credit terms but selling goods only for cash. The working capital requirement of the firm will be lower than that of a firm which is purchasing cash but has to sell on credit basis.
7. Supply Conditions : The time taken by a supplier of raw materials, goods etc., after placing an order, also determines the working capital requirement. If goods are received as soon as or in short period after placing an order, then the purchaser will not like to maintain a high level of inventory ofthat goods. Otherwise, larger inventories should be kept e.g., in case of imported goods. It is often seen that the shopkeepers may not be keeping stock of all items, but whenever there is a demand, they procure from the wholesaler/ producer and supply it to their customers.
8. Working Capital Cycle : In a manufacturing concern, the workinry capital cycle starts with the purchase of raw material and ends with the realisation of cash from the sale of finished products. This cycle involves purchase of raw materials and stores, its conversion into stocks of finished goods through work-in-progress with progressive increment of labour and service costs, conversion of finished stock into sales, debtors and receivables and ultimately realisation of cash and this cycle continues again from cash to purchase of raw material and so on. The speed with which the working capital completes one cycle determines the requirements of working capital, longer the period of the cycle, larger is the requirement of working capital.
9. Growth and Diversification of Business : Growth and diversification of business call for larger volume of working fund. The need for increased working capital does not follow the growth of business operations but precedes it. Working capital need is in fact assessed in advance in reference to the business plan.
10. Banking Relations : A good bank-customer relationship is a pre-requisite of a successful working capital management policy. Commercial banks these days normally finance the working capital gap (based on set norms by Tandora and Chorey Committees) credit Authorisation scheme has also been liberalised after 1986. Thus customers receive an assured bank finance which minimises the need for making over-investment in current assets.
11. Price Level Changes ; Changes in the price level also affect the working capital requirements. Generally, the rising prices will require the firm to maintain larger amount of working capital as more funds will be required to maintain the same current assets. The effect of rising prices may be different for different firms. Some firms may be affected much while some others may not be affected at ail by the rise in prices.
12. Other Factors : Certain other factors such as operating efficiency, taxation policy, dividend policy, etc., also influence the requirements of working capital. Thus, the working capital requirement of a firm is determined by a host of factors. Every consideration is to be weighted relatively to determine the working capital requirement. Further, the determination of working capital requirement is not once a while exercise, rather a continuous review must be made in order to assess the working capital requirement in the changing situation. There are various reasons which may require the review of the working capital requirement e.g., change in credit policy, change in sales volume etc.
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