Among the list of various factors, size for the business is important for working capital requirement. Apart from these there are factors affecting working capital requirement like: taxes, production cycle and more. Also there are working capital requirement problems with solutions from different methods of estimating working capital requirement. In order to boost selling volume, your enterprise requires to maintain their current assets. Lesser your working cycle period, lesser will be working capital requirement and vice versa. Here we will understand what is working capital requirement, how to calculate working capital requirement along with net working capital requirement formula and methods of forecasting working capital requirements.
The estimation of working capital also changes based upon your nature for the business. For example, trading businesses need a lot more working capital as compared to manufacturing businesses. This really is because your trading business needs huge quantity of products as stocks which leads to huge amounts to working capital then manufacturing businesses. An additional crucial factor or component of working capital requirement relates to terms of credit permitted to the customer base. For example: one enterprise may perhaps extend credit facilities to 15 days for all their customers, while another enterprise in the same business may stretch credit facilities to 90 days only to select and reliable customer base only.
What is Working Capital Requirement?
Working Capital Requirement define as total finance needed fill the gab around cash received by customers as well as payments to be made to vendors. In other words, working capital requirement means the sum of current assets to cover the cost of working expenses of the business. Almost every organization need to spend money to generate revenue. Their nature of these expenses depends on the operational task.
Their two main parts of working capital are current assets and current liabilities. Estimation of working capital requirement represents the sources of working capital finance required to fill the delay gap in receiving and making payments.
Net Working Capital Requirement Formula
We can calculate estimation of net working capital requirement by formula. In simple terms, when inventory and account receivable increases whereas accounts payable decreases, this means that required net working capital is increasing and improving. You can also learn more in detail about what is current assets with examples and what is current liabilities with examples for more knowledge. Net working capital requirement formula is given below:
Required Net Working Capital = (Inventory + Cash Receivable) – Cash Payable.
Estimation of Working Capital Requirements
Business should be able to calculate estimation of working capital requirement. In simplest language, this is calculated based revenue in percentage of working capital requirement. Once finalized, chose either sources of equity financing or sources of debt financing based on your requirement. Figure keeps on changing unless business is fairly steady and stable.
Let us take an estimation of working capital requirement example to understand better. Assume that net working capital requirement is 15.0% of revenue. You can also read about what is revenue with examples to understand better.
Now suppose business offered a newer agreement of 50,000 in revenue and you know how to calculate working capital requirement for manufacturing company. It is probably additional 7,500 (50,000 x 15%) finance needed to manage the growth of the business.
Different Methods of Estimating Working Capital Requirement
There are many types of capital in business. Also there are various factors affecting working capital requirement. Even there are factors determining working capital requirement. Due to which there are different methods of forecasting working capital requirements. They are broadly categorized in 5 methods of estimating working capital requirement. They are as follows:
- Cash Forecasting method for forecasting.
- Percentage of Sales / Revenue methods of estimating.
- Projected Balance Sheet method for forecasting.
- Operating Cycle methods of estimating.
- Regression Analysis is another different methods of estimating.
Facts and figures should be correct and accurate for planning based on different methods for estimation of working capital requirement. Looking for short term sources of financing, then this become the primary requirement for you. As Banks and financial lenders requires these estimation for financing your operational expenses.
Top 10 – Factors Affecting / Determining Working Capital Requirement
Here are the top 10 factors affecting requirement of working capital. This also assist you in identifying top 10 factors determining working capital requirement problems with solutions as well.
Type of Business
In small companies, the initial investment in assets is actually lower and required working capital is higher. While big companies incur higher investment upon initial fixed capital than working capital requirements.
Nature of Interest
If the customers interest in the company`s product increases which means that company will incur a high working capital. In case the demand / interest for the product is lower, then company may require lower working capital.
Size of Business
If size of business is huge with wide range of strategies then to undertake those activities, requirement of working capital is more as compare to small size of businesses.
Turnover of Inventories
In case inventories are huge but business have slow turnover, such enterprise will need more working capital. Vice versa, in case inventories are low but business have quick turnover, then that enterprise will need a low working capital.
Degree of Taxes
Higher level of taxes means, higher working capital requirements. Although lower level of taxes means, low estimation of working capital requirement.
Production Cycle / Manufacturing Cycle
In case of continuous as well as constant production / manufacturing, working capital requirements will be higher. Whereas required of working capital will be lower in the event of random / discontinued / irregular / scattered production / manufacturing.
Working capital requirements is higher during the growth phase of a company. Once the company is stable, required working capital get lower.
Length of Working Cycle
Transformation of cash through different phases like: raw materials, finished product, sales and bills receivables to cash takes a certain time which is called length of working cycle. Longer your working cycle period, higher their working capital requirements.
Credit Finance Policy
In the event that company buys raw materials on credit period and finished products are sold on cash basis. Then, low estimation of working capital requirement for a company. In reverse scenario, required working capital will likely be increased.
Availability and Accessibility of Raw Materials
Assuming raw materials is available and accessible at any given point of time. In that case, company can even maintain a low working capital. However, in case of shortage of raw material, the company need to keep additional reserve of their raw material every time. In that case required working capital will be higher.
We have observed that price of the goods in businesses widely fluctuate. It clearly boosts the factors affecting working capital requirement associated with the businesses. Here we have seen various other factors determining working capital requirement that plays a vital role in how to calculate working capital requirement for manufacturing company. It is important to properly calculate by net working capital requirement formula. You should check by way of different methods of estimating working capital requirement problems with solutions and methods of forecasting working capital requirements. Do leave your feedback below. You additional knowledge will assist other reads as well.
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Basics of Working Capital Management for Beginners
- Chapter 1: What is Working Capital Management?
- Chapter 2: Importance of Working Capital Management
- Chapter 3: Objectives of Working Capital Management
- Chapter 4: Types of Working Capital
- Chapter 5: Components of Working Capital Management
- Chapter 6: Working Capital Cycle
- Chapter 7: Working Capital Finance
- Chapter 8: Net Working Capital
- Currently Reading: Working Capital Requirement
- Chapter 10: Working Capital Management Quiz For Beginners
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