Internal and External Factors That Affect Working Capital
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Internal and External Factors that Impact Working Capital

Ryan Thompson
Ryan Thompson
November 9, 2022
Last updated on:

November 9, 2022


Read time: 5 mins

In any business, managing working capital is a never-ending task for the finance and accounting personnel. A constant inflow of funds has to be ensured to keep the daily operations of the company motoring along smoothly. In order to achieve this, organizations need to understand which factors affect the flow of working capital. These influencers can be divided into two groups: internal and external.

Internal Factors That Affect Working Capital

1. Company Size and Growth Rates:

For companies that are on the fast track to growth, meeting the increasing demand for their products and services, brings with it the requirement to acquire more raw materials and speed up the rate of production. They also need to spend more time marketing and distributing their goods and services in new locations. All this requires considerable funds and that increases the working capital required by the enterprise.

2. Organizational Structure:

How the company is built and how it is run often decide how the working capital is used. Some use more working capital and produce less, thus being inefficient. Other companies are more efficient, and thus, produce more goods with less use of capital. Some organizations are more bureaucratic, their production, marketing, and distribution centers are located far away from each other and there is too much documentation being passed back and forth thus increasing the cost spent on each order. Other companies are lean; they operate with fewer staff, their centers of production, storage, and distribution are close to each other, and they are thus able to save a sizable amount of unnecessary expenses.

3. The sophistication of Working Capital Management:

Some accounting teams are just better at working with the cash that the business has. They do not allow their customers long credit periods, they negotiate favorable terms with their creditors, they price their products judiciously, they have access to loans from banks and are able to raise short-term liquidity in the money market, and they keep their working capital cycle as short as possible.

4. Borrowing and Investing:

How does the company invest its borrowings? Some of the avenues into which investments are channeled include the building of better storage facilities, improvement and streamlining of processes, efficient new machinery, training and development, diversification of product line, entry into new markets, the building of new capabilities, and other end uses. The end use of the investment has a strong impact on the level of working capital.

External Factors That Affect Working Capital

1. Banking Services:

The inability to raise capital from banks can afflict the working capital of an organization. This can be due to many reasons, such as inadequate documentation, a default in the past, etc. Companies that are able to access banks for financing, or raise funds through issuing debt or equity capital, will most likely have a healthy rate of liquidity to keep their operations running smoothly.

2. Interest Rates:

When interest rates are high, it becomes expensive to borrow funds. Many companies might think twice about borrowing or even if they do borrow, the cost of paying back the loan hits their bottom line. Life is easier for businesses when interest rates are lower, and liquidity is easily available and not quite so expensive. Then taking a short-term loan for improving the working capital situation would be more viable.

3. New Technologies and New Products:

Some of the leading companies in the world today use technology to forecast their demand better; manage the channels through which their products are distributed, and procure the required level of raw materials at the right time. Online invoicing and payments allow the company to reduce their Days Sales Outstanding. Technology and automation are, thus, used to optimize the working capital.

4. The Economy:

Market conditions, the nature of the domestic economy and the global economy, political risks, environmental risks, and business risks all have an impact on the working capital. The wider the international operations of the business, the more diverse the risks and the greater the threat of the supply chain breaking down. A business has to constantly plan ahead for the future to make sure that at no point does its capital situation become adverse.

5. The Threat of Competition:

The customer is undisputedly and considered to be the king in a competitive business landscape. If a rival gives discounts and hefty credit terms, then the company has to either match it or give even better terms. It might have to pay dividends, and might not be able to negotiate with the vendors either. The business might find itself losing control over the inflow of cash, and when that happens, then their working capital gets affected as well.

There are, thus, several factors that affect working capital. Companies might not have much control over the external factors and can only deal with them as best as they can. However, they can work harder at becoming more financially efficient internally, avoiding wastage, and finding ways of reducing production, distribution, and marketing costs. This way, they will have more capital at hand to channel into their business and streamline their operations.

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