Working Capital

The need for working capital or current assets arises from the operating or cash cycle of the firm. The operating cycle refers to the length of time to convert the non-cash current assets into cash. In other words cash cycle refers to the time involved in completing the following sequence of events: conversion of cash into inventory, conversion of inventory into receivable and conversion of receivables into cash. If it were possible to complete these sequences instantaneously, there would be no need for current assets. But since nature of these activities is such that a perfect synchronisation is not possible, a certain minimum level of current assets is necessary.

The working capital can be divided into permanent or temporary, depending on the need of the firm. The permanent component reflects the need for a certain irreducible level of current assets on a continuous and uninterrupted basis. The temporary portion of the working capital requirement is needed to meet seasonal and other temporary requirements.

The working capital requirements are determined by a variety of factors. In general the following factors are relevant for proper assessment of the quantum of working capital required: general nature of business, production cycle, business cycle, production policy, credit policy, growth and expansion, availability of raw materials, profit level, level of taxes, dividend policy, depreciation policy, price level changes and operating efficiency.