Question

Explain the following factors affecting the working capital requirements of a company: (i) Operating Efficiency (ii) Business Cycle (iii) Credit…

Accepted Answer

Factors affecting the working capital requirements of a company: • (i)Operating Efficiency: Firms manage their operations with varied degrees of efficiency • in managing raw material, sales, etc. Operating efficiency reduces the level of raw materials, finished goods and debtors resulting in lower requirement of working capital. • (ii) Business Cycle: In case of a boom, the sales as well as production are likely to be larger and, therefore, larger amount of working capital is • required. During the period of depression, the requirement for working capital will be lower as the sales as well as production will be small. • (iii) Credit Allowed: Different firms allow different credit terms to their customers, depending upon the level of competition as well as the credit • worthiness of their clientele. A liberal credit policy results in higher amount of debtors, increasing the requirement of working capital. (iv) Availability of Raw Material: • 28 If the raw materials and other required materials are available • freely and continuously, lower stock levels may be sufficient. Moreover, larger the lead time (the time lag between the placement of order and actual receipt of the materials), larger the quantity of material to be stored and larger shall be the amount of working capital required. OR: Factors affecting the choice of capital structure of a company: • Flexibility: A firm loses flexibility to issue further debt if it uses its debt • potential to the full. To maintain flexibility, it must maintain some borrowing power to take care of unforeseen circumstances. • Floatation Costs: Process of issuing shares and debentures involves some cost, while obtaining a loan from a financial institution may not cost • so much. These considerations also affect the choice between debt and equity, and hence capital structure. Stock Market Conditions: • 29 Companies prefer to use equity if the stock markets are bullish, • as equity shares are more easily sold even at a higher price. However, during a bearish phase, a company, may find raising of equity capital more difficult and it may opt for debt. • Control: A public issue of equity may reduce the managements’ holding • in the company and make it vulnerable to takeover. However, debt normally does not cause a dilution of control.

Explain the following factors affecting the working capital
requirements of a company:
(i)
Operating Efficiency
(ii)
Business Cycle
(iii)
Credit Allowed
(iv)
Availability of Raw Material

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