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Internal and External Factors That Affect Working Capital

Narendra Kumar

| Updated: Dec 13, 2017 | Category: Finance & Accounting, Financial Reporting

Working Capital

The process of managing working capital is one that never ends for finance/accounting workers in a business. It’s important to maintain a continuous flow of income in order to maintain the company’s day-to-day operations and keep the business operating without any major hitches. The two main types of influences are internal and external ones.

Internal Factors

  • Structure of the Organization

The way a company is structured and how it operates often determines how it uses working capital. There are some companies that use more working capital and also produce less. This makes companies more inefficient. Meanwhile, other companies have higher efficiency and also need less capital to manufacture more goods.

There are organizations that use more bureaucracy so their marketing, production, and distribution centers are in a location that’s far from the others. They share a ton of documentation with each other. These results in boosting the price spent on others. Meanwhile, other companies are more streamlined. They have a smaller group of staff and their hubs of production, distribution, and storage are situated near each other. As a result, they can save a lot of money by preventing expenses that are unnecessary. This helps to make the companies more efficient. This is important since it results in more productivity and profitability.

  • Borrowing/Investing

How do companies invest the capital they’ve borrowed? Some of the ways investments are used include improving/streamlining processes, building improved storage facilities, training/development, using efficient new machines, entering new markets, diversifying offerings, adding new capabilities, etc. The level of working capital is greatly affected by the final use of these investments.

In theory, companies should avoid the need to borrow capital. However, when it’s needed it’s important to invest the funds in effective ways. That helps to produce the best results for the company.

  • Company’s Size/Growth Rates

When companies are on the fast road to growth the process of meeting higher demand for products/services results in acquiring increasing daily production rates and purchasing more raw materials. There’s also more time needed for marketing/distribution the company’s offerings in various new locations. This entire process requires a large number of funds, which boosts the amount of working capital the business needs.

  • Working Capital Management’s Complexity

Some accounting teams are more efficient at operating with the business’ cash on hand. In this case, they don’t allow their customers to have long-term credit. They also negotiate with creditors for variable terms, access loans from banks, price products effectively, maintain a short working capital cycle and in the money market can raise liquidity in the short term. These factors show the complexity of the management of working capital.

External Factors

  • Interest Rates

In the case of high-interest rates, it becomes very pricey for companies to borrow capital. Several companies might hesitate to borrow or if they take that step the effect of the repaying the loan on their profits. It’s easier for businesses when they can enjoy low-interest rates and liquidity is affordable and accessible. In that case, taking out a short-term loan in order to improve their status of working capital might be a more practical option.

  • The Economy 

There are several factors on working capital in terms of the economy including the domestic/global economy, marketing conditions, business, political, and environmental risks. All of these factors can affect a company’s working capital and are major external factors.

The more international a business’ operations are the more diverse risks and more threat to the break-down of the company’s supply chain management. A company must constantly plan for the future to ensure that the capital situation never becomes an issue. This is a continuous process so it’s important to be vigilant in order to produce the best results.

  • Banking Services

When companies aren’t able to secure capital from banks it can have a negative effect on a company’s working capital. This can be due to various reasons including past defaults, not enough documentation, etc. A business that is able to finance through banks or raise funds via issuing equity capital or debt will probably have a high rate of liquidity in order to maintain smooth business operations. This is one of the main goals because it’s crucial for a company to have operations that run smoothly.

  • New Tech/Products

Today’s top global companies include those who use tech to project their demand more accurately, buy the number of raw materials at the proper time, and manage the distribution channels of their products. When companies use online invoicing/payments they can lower several expenses in order to make their working capital better optimized. This is one of the most critical issues involving today’s companies in terms of external factors.

  • Rival Companies’ Threats

The customer is easily classified as the key to a business landscape that’s competitive. In the case, a competitor provides big credit terms and discounts the business has to match it or provide better terms. The company might be required to pay a dividend and might be unable to negotiate with its vendors. This can result in the company losing control of its cash flow. What’s the result? In the case that takes place, the working capital is also affected.

There’s no doubt that many factors can affect a company’s working capital. This is a critical issue so it’s important for your business to be as knowledgeable as possible about the factors. On one hand, a company might have little control over the various external factors. In that case, the key is to take whatever steps you can in order to deal with the situation effectively.

On the other hand, a company can also work diligently to internally be more financially efficient. This helps to avoid waste and being in the situation of finding methods for reducing the costs of distribution, production, and marketing. When that happens, a company has more capital it can use to funnel into its company and make its operations more efficient. This is one of the most important goals of any company as it helps them to be more efficient and thus more profitable.

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Narendra Kumar

Experienced Finance and Legal Professional with 12+ Years of Experience in Legal, Finance, Fintech, Blockchain, and Revenue Management.

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