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Question
Explain the following as factor affecting the requirement of working capital:
Business cycle
Solution
In various phases of the business cycle, the requirement of working capital is different. For instance, in the phase of the boom, both production and sales are higher. Accordingly, the requirement of working capital is also high. As against this, in the phase of depression, the demand is low, and so production and sales are low. Accordingly, there is less requirement of working capital.
Boom period ⇒ High working capital
Depression period ⇒ Low working capital
The business cycle influences the working capital requirements of a business as follows:
- During Expansion: During the expansion phase of the business cycle, economic activity increases and demand for products and services rises. Businesses may need to boost working capital to support increased output.
- During Contraction: During the contraction phase, economic activity slows and demand for products and services decreases. Businesses may face reduced revenues, excess inventory, and liquidity issues. Businesses may need to cut working capital due to reduced cash flows and tighter lending conditions.
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