Zeta Ltd. assembles and sells water purifiers. Keeping its volume of production and sales the same, it starts buying components on three months’ credit and selling the finished purifiers for cash instead of on credit. Which of the following is correct about its working capital requirement?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → It will be lower, as credit on purchases reduces it and cash sales leave no debtors.
Option (1) It will be higher, as goods bought on credit add to stock and cash sales call for more cash in hand. — Incorrect. Production is unchanged, so the stock held stays the same; buying on credit changes only when the supplier is paid. Until then the supplier finances the stock, so less of the firm’s own money is needed. Cash sales bring money in at once, so no funds are locked in debtors.
Option (2) It will stay the same, as the volume of production and sales is unchanged. — Incorrect. Volume is only one factor. Credit terms also decide how much money is locked up in stock and debtors.
Option (3) It will stay the same, as credit on purchases and cash sales change the timing of payments, not the volume of business. — Incorrect. Timing is what changes the need. Paying later and being paid at once leaves less money locked up.
Option (4) It will be lower, as credit on purchases reduces it and cash sales leave no debtors. — Correct. Zeta now gets three months’ credit, so suppliers finance its components for that time. Selling for cash means it allows no credit, so there are no debtors to finance. Both cut the working capital needed.
Credit availed is credit the firm gets from suppliers and lowers the need. Credit allowed is credit it gives customers and raises the need.
NCERT (2026-27 Edition): “Factors Affecting the Working Capital Requirements … 6. Credit Allowed: Different firms allow different credit terms to their customers. These depend upon the level of competition that a firm faces as well as the credit worthiness of their clientele. A liberal credit policy results in higher amount of debtors, increasing the requirement of working capital. |