Explain four factors that influence the working capital requirements of a firm
Working capital in business finance refers to the difference between a company’s current assets and its current liabilities. A company needs good working capital to ensure that its operations run smoothly and that the firm meets its financial obligations as they fall due. There are several factors that affect the firm’s working capital.
- Nature of business: the nature of business affects the firm’s working capital requirements. Manufacturing firms need more working capital because they have longer operating cycles and require more raw materials and inventory storage. On the other hand, service companies need less working capital because they often operate with lower levels of inventory
- Business cycle: another factor that affects the working capital requirements of a firm is the stage of business cycle of the firm. In the growth stage, a company needs more working capital due to increased production and inventories.
- Production cycle: production cycle also determines a company’s working capital requirements because a longer production cycle ties up more funds in inventory, hence requiring more working capital.
- Credit Policy: they say the more the generosity of credit terms for a business, the more the accounts receivable, hence the more the working capital needed.
- Seasonality of operations: a company that deals with more seasonal business means that they get demand on seasons, such as holidays for retailers. These businesses require higher working capital during peak seasons to stock up inventory and increase sales.
- Operating efficiency
- Market conditions
- Profit margins
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