Page 2 - Lesson Note 6

are due for payment within one year; such as bills payable, creditors, outstanding

expenses and advances received from customers, etc. Some part of current assets
is usually financed through short-term sources, i.e., current liabilities. The rest is

financed through long-term sources and is called net working capital.

Thus, NWC = CA – CL (i.e. Current Assets - Current Liabilities.)

Thus, net working capital may be defined as the excess of current assets over

current liabilities.

FACTORS AFFECTING THE WORKING CAPITAL REQUIREMENTS

1. Nature of Business: The basic nature of a business influences the amount of
working capital required. A trading organization usually needs a smaller amount

of working capital compared to a manufacturing organization. This is because
there is usually no processing. Therefore, there is no distinction between raw

materials and finished goods. Sales can be effected immediately upon the receipt
of materials, sometimes even before that. In a manufacturing business, however,
raw material needs to be converted into finished goods before any sales become

possible. Other factors remaining the same, a trading business requires less
working capital. Similarly, service industries which usually do not have to maintain

inventory require less working capital.

2. Scale of Operations: For organizations which operate on a higher scale of
operation, the quantum of inventory and debtors required is generally high. Such
organizations, therefore, require large amount of working capital as compared to

the organizations which operate on a lower scale.

3. Business Cycle: Different phases of business cycles affect the requirement of
working capital by a firm. 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. As
against this, the requirement for working capital will be lower during the period
of depression as the sales as well as production will be small.