Every organisation, no matter the scale, requires sufficient working capital to keep its operations afloat. Financial experts recommend a working capital ratio above 1.5 to ensure an organisation’s current assets can mitigate its short-term liabilities adequately. It’s a crucial prerequisite for the growth of any business.
Nevertheless, to ensure proper working capital management, it’s first necessary to determine the requirement appropriately. In that regard, a few factors come into play. One is the nature of a business, which plays a critical role in determining the amount of working capital required.
For instance, a manufacturing organisation will need higher working capital compared to a business based on wholesale and distribution.
Another factor to consider is the operating cycle. It’s the time between raw material acquisitions to receiving payment from debtors. The longer this period, the more working capital a business shall need.
Also, the volume of credit sales influences the determination of working capital. Organisations primarily selling their products on credit require higher working capital financing to mitigate its short-term obligations and vice versa.
Apart from that, enterprises often avail business loan to optimize their cash flow when their credit terms extend to all their clients for a prolonged period of 90 days or more. Businesses should also factor in seasonal demand when determining their working capital requirements. Another consideration is that of financial contingencies.
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