Changes in Working Capital

The changes in the level of working capital occur for the following three basic reasons: (i) changes in the level of sales and or operating expenses, (ii) policy changes, and (iii) changes in technology.

Changes in Sales and Operating Expenses

The first factor causing a change in the working capital requirement is a change in the sales and operating expenses. The changes in this factor may be due to three reasons. First, there may be a long run trend of change. For instance, the price of a raw material say oil may constantly rise, necessitating the holding of a large inventory. The secular trends would mainly affect the need for permanent current assets. In the second place, cyclical changes in the economy leading to ups and downs in business activity influence the level of working capital, both permanent and temporary. The third source of change is seasonality in sales activity. Seasonality peaks and troughs can be said to be the main source of variation in the level of temporary working capital.

The change in sales and operating expenses may be either in the form of an increase or decrease. An increase in the volume of sales is bound to be accompanied by higher levels of cash, inventory and receivables. The decline in sales has exactly the opposite effect a decline in the need for working capital. A change in the operating expenses rise or fall has a similar effect on the levels of working capital.

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