A variety of factors influences working capital requirements. The majority of company activities influence the company’s working capital requirements. Their impact may vary in magnitude. Consider the following factors to determine the sources of working capital:

Competition

Competitive industries require quick responses to customer needs, so higher inventory levels. Good service, as well as liberal credit terms, are essential. As a result, the more competitive the market, the more sources of working capital would be required.

Industry seasonality and Production Policies

Some businesses are manufacturing air conditioners whose demand peaks in the summer and dips in the winter based on seasons. A product made in their demand will require more working capital in summer than in winter. The working capital turnover ratio fluctuations can be smoothed by producing year-round.

Credit extension policies 

Small businesses must sell on a deferred payment basis to secure their business and generate revenue. According to the credit policy, clients have a certain amount of time to pay back their dues to your company. A longer period will require you to have more working capital.

Small business owners often leniently collect money from clients in debt to them. Even though the agreed-on payment date has passed, an entrepreneur might hesitate to ask for payment since this may hamper the relationship and future sales possibilities. While such practices seem beneficial to the company, they can negatively impact its working capital turnover ratio situation. 

Operating cycle duration 

Typically, firms with a large production volume, such as those in automobile manufacturing, will have a longer operating cycle, while firms with a smaller volume of production, such as bakeries, will have shorter operating cycles. 

Consequently, the former will require considerably more working capital than the latter. Depending on how long production takes, entrepreneurs must make appropriate financial arrangements. It would be best to have working capital in direct proportion to the length of your operating cycle. 

Longer periods will require more money. A company’s operating cycle corresponds to the number of days it takes to procure materials to collect against sales from customers. Many days or months are typically used.

Inventory management 

Inventory management can be done in several ways. It is best to choose one that fits your company’s needs and is within the scope of the time it takes to deliver a commodity to your clients. 

However, a company’s working capital can be affected by the policy it adopts and practices. Choosing a just-in-time or JIT strategy necessitates a lower working capital requirement than a company that stocks up well in advance.

Businesses that deal with perishable products can also benefit from a JIT policy. Over-stocking is not recommended unless necessary for cost-saving or tax-saving purposes to avoid blocking a chunk of working capital. 

Supplier bargaining power 

Predecessors are the companies we buy materials from or outsource services to in a supply chain. The business can then further refine and process these inputs and then sell them to its clients. We negotiate the price and terms and conditions with these predecessors or suppliers in most cases.

Working capital requirements are inversely proportional to this factor. You have a better chance of lowering the price or obtaining credit terms the more bargaining power you have over your suppliers.

Sales 

Working capital is determined, among other things, by the size of sales. Keeping the enterprise’s current assets in good condition increases sales volume. The organization can balance its current assets with its annual sales in a steady ratio as time passes. This leads to a reduction in the length of the operating cycle as the turnover ratio, i.e., current assets to turnover, increases. As a result, the shorter the operating cycle period, the lesser the need for working capital, and the reverse is also true.