Question 5 OR (a)
Working capital and its determinants
6 marks
- Time to write
- About 12 minutes
- Topic
- Working capital
Question
Question 5 OR (a) · 6 marksWhat is meant by Working Capital? Discuss the determinants of a firm's working capital needs.
Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- What is meant…?Discuss…2 asks, each with its own marks below. Answer both.
Write it in this order
- Read; underline the asks; jot your points 1 min
- 1 Meaning: gross and net working capital 2 marks 3 min
- 2 Determinants explained 4 marks 7 min
- Check: every ask answered, key terms underlined 1 min
Easy marks
- Step 1 opens with the meaning: a one-line definition, the quickest mark in it.
Short on time? Trim steps 1 and 2 evenly rather than skip one: each is capped at its own marks.
Try it first. About 12 minutes for 6 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Meaning. Working capital is the fund needed for a firm's day-to-day operations: buying raw materials, paying wages and other running expenses. It is also called circulating or short-term capital. There are two concepts:
- Gross working capital: the total investment in current assets (cash, stock, debtors, bills receivable, prepaid expenses and so on);
- Net working capital: current assets minus current liabilities; it is positive when current assets exceed current liabilities.
Determinants of working capital needs
- Nature of business: public utilities selling services for cash need little; trading and financial firms need a great deal; manufacturers fall in between.
- Size and scale of operations: the larger the business, the more working capital it needs.
- Production policy: steady production through the year, building stocks in the slack season, needs more working capital than producing to match seasonal demand.
- Length of the production cycle: the longer the manufacturing process, the longer funds stay tied up in work-in-progress.
- Credit policy: buying on credit and selling for cash needs little; buying for cash and selling on credit needs much more.
- Business cycles: a boom needs more working capital for higher sales and prices; in a depression funds may lie idle.
- Rate of growth: fast-growing firms need large and rising working capital.
- Earning capacity and dividend policy: high cash profits add to working capital; a high cash dividend drains it.
- Price level changes: rising prices require more funds for the same volume.
Where the 6 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Meaning: gross and net working capital | 2 |
| 2 | Determinants explained | 4 |
| Total | 6 |
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