Setting up a Small Business: Factors Determining Working Capital, Cost of Labour, Length of Operating Cycle, Terms of Purchase and Sale (For CBSE, ICSE, IAS, NET, NRA 2022)

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Factors Determining Working Capital

  • Working Capital is the capital required to meet day to day expenses like wages, rent, electricity and water charges, and to be invested in the current assets, such as debtors՚ stock of raw materials, semi-finished goods, finished goods etc. Working capital is also called circulating capital. This is because investment in current assets are recovered and reinvested repeatedly in course of business operations. Going by the above meaning of working capital, its requirements may be met by short-term funds. However, since the business is a continuing concern it must at all times have a certain amount of working capital, which in effect is of a fixed nature. This may be regarded as the permanent part of working capital.
  • Following are the various factors that need to be considered to estimate the requisite amount of working capital.
Factors Determining Working Capital

Proportion of Cost of Raw Materials to Total Cost

If the raw materials account for a major portion of the total cost of the finished product, more working capital is required.

Cost of Labour

If labour intensive methods of production are used more working capital will be required.

Length of Operating Cycle

If more time is taken in the completion of the production process and the sale of the products, higher investment will be required in inventories and wage bills and hence more working capital will be needed.

Terms of Purchase and Sale

If raw materials and other services are available on credit and goods produced are sold for cash, less working capital investment will be involved. On the other hand, if raw material is to be purchased for cash and goods produced are sold on credit, larger amount of working capital will be necessary.

Cash Requirements

The amount of cash needed to meet the operating expenses like wages, rent, freight, taxes etc. also determine the amount of working capital.

Seasonal Operations

  • Business units engaged in manufacturing seasonal goods are required to have a relatively larger amount of working capital. The recovery of working capital through sales of such products is limited to a particular period, and hence a large amount of working capital is required to meet off – season requirements.
  • Having discussed the various factors considered for estimating the capital requirement of a business unit, you must be thinking from as to where and how one can arrange the funds for the business.

Sources of Capital

The financial requirement of any business can be met from

  • Owners՚ capital
  • Borrowed capital

The owners՚ capital is provided by the owners from their own savings. But this may not be sufficient to meet the total capital requirement of business. So, the business needs to borrow capital from the outsiders. Money can be borrowed from friends, relatives, moneylenders, and commercial banks. Then there are some financial institutions like Small Industries Development Corporations and Small Industries Development Bank of India which provide capital support on easy terms to small-scale units. The manufacturers and suppliers of raw materials and goods also provide support in various ways. In case of certain type of goods in high demand, the customers may give advance money to the supplier which also acts as an important source of finance.

From all the above sources the business can get the required funds in various forms. For example, commercial banks provide funds in the form of cash credit, overdraft, discounting of bills and loans. The suppliers and manufactures give trade credit, instalment credit to the traders՚.

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