Before getting into the details regarding the factors that affect working capital cycle, it is better to grow a little concept about it. The working capital cycle is basically the amount of time it takes to turn the net current assets and current liabilities into cash. It so happens that, longer the cycle is, the longer a business is tying up capital in its working capital without even earning a return on it. Hence, the companies struggle to reduce the working capital cycle by collecting receivable values or also stretching accounts payable at times. This is how the working capital cycle functions. In the very first step of the process, the company gets the materials it needs to produce inventory but doesn’t initially have any cash expense. As far as positive working capital cycle is concerned, it balances the incoming and outgoing payments in order to minimize the net working capital and also maximize the free cash flow. This helps in the free going of the concerned business.
Every growing business requires cash and being able to free up the cash by the process of shortening the process of working capital cycle considered the most inexpensive or reasonable way to grow. But this also has to be considered that there are certain important factors that determine the functioning of this. As far as sophisticated buyers are concerned, they closely review the working capital cycle of a target because it provides them with a genuine idea of the effectiveness of management at managing process of their balance sheet and generating free cash flow. This helps in the smooth going of the business.
There are certain factors that affect the overall working capital cycles and that can’t be denied. What is working capital cycle has already been discussed above, now the factors need to be discussed a bit.
Nature of business is one of the fundamental determinants of the working capital cycle. The requirement of working capital depends on the nature of business. The nature of business is usually of two types: Manufacturing Business and Trading Business.
One of the most crucial factors affecting working capital cycle is certainly scale of operations. It has direct link with the working capital cycle and they are interdependent.
Business cycle is yet another determinant which has great role to play. During the flourishing period, the demand for any product increases and sales also increase simultaneously. Therefore, more working capital is needed. You may read Importance of having a business plan here to more understand how the business flow can be managed.
Seasonal factors cannot be denied in any way. This to a great extent decides what is the right level of working capital which will help in the business process altogether. Some goods are demanded throughout the year while others have seasonal demand. Hence, this decides the level of working capital required altogether.
Production cycle is yet another factor that can never be denied in this regard. If the period is longer, the time will also be more, for which the capital remains blocked in the form of raw materials and semi-manufactured products.
All the factors discussed above are the mandatory ones that truly affect the entire working capital cycle and the process has no value without these determinants. Level of competition also plays a vital role as determinants while inflation is applicable in some cases.