Explain the following factors affecting the working capital requirements of a business :
(i) Credit allowed
(ii) Production cycle
(iii) Availability of raw material
Ans.
(i) Credit allowed:
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Credit allowed refers to the practice of extending credit to customers, allowing them to purchase goods or services on account and pay for them at a later date.
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When a business allows credit to its customers, it ties up its funds in accounts receivable, which increases the working capital requirement.
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The longer the credit period offered to customers, the higher the amount of working capital needed to finance the gap between the time of sale and the time of cash collection.
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Additionally, the credit policy of the business, including credit terms, credit limits, and collection efforts, also influences the working capital requirements.
(ii) Production cycle:
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The production cycle refers to the time required to convert raw materials into finished goods and sell them to customers.
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Longer production cycles result in higher working capital requirements as more funds are tied up in inventory and work in progress.
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Factors such as production lead times, batch sizes, manufacturing processes, and inventory turnover rates affect the duration of the production cycle.
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Businesses with shorter production cycles typically require less working capital compared to those with longer production cycles, as they can convert inventory into cash more quickly.
(iii) Availability of raw material:
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The availability of raw material refers to the ease with which a business can procure the necessary materials and components for production.
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Adequate availability of raw material reduces the risk of production delays and shortages, thereby minimizing the need for excess inventory and working capital.
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However, if raw materials are scarce or subject to price fluctuations, businesses may need to maintain higher levels of inventory to mitigate supply chain risks, resulting in increased working capital requirements.
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Factors such as supplier reliability, lead times, transportation costs, and inventory management practices influence the availability of raw material and its impact on working capital.
