Firm A and Firm B make the same product on the same scale. Firm A takes about six months to convert its raw material into finished goods, while Firm B takes about one month.
Which firm needs more working capital, and why?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Firm A, as its production cycle is longer
Option (1) Firm A, as its production cycle is longer — Correct. The production cycle is the time from receiving raw material to turning it into finished goods. Funds stay tied up in materials and expenses for this whole period. Firm A takes six months and Firm B one month, so Firm A needs more working capital.
Option (2) Firm B, as its production cycle is shorter — Incorrect. A shorter cycle frees funds sooner. So Firm B needs less working capital than Firm A.
Option (3) Firm A, as its lead time is longer — Incorrect. The firm is right but the reason is wrong. Lead time is the gap between placing an order for materials and receiving them. The question gives the time to convert raw material into goods, which is the production cycle.
Option (4) Firm B, as its lead time is shorter — Incorrect. Both the firm and the factor are wrong. The question says nothing about ordering materials, and a shorter lead time would lower the need.
NCERT (2026-27 Edition): “Factors Affecting the Working Capital Requirements … 5. Production Cycle: Production cycle is the time span between the receipt of raw material and their conversion into finished goods. Some businesses have a longer production cycle while some have a shorter one. Duration and the length of production cycle, affects the amount of funds required for raw materials and expenses. Consequently, working capital requirement is higher in firms with longer processing cycle and lower in firms with shorter processing cycle.” “Factors Affecting the Working Capital Requirements … 9. Availability of Raw Material: If the raw materials and other required materials are available freely and continuously, lower stock levels may suffice. If, however, raw materials do not have a record of un-interrupted availability, higher stock levels may be required. In addition, the time lag between the placement of order and the actual receipt of the materials (also called lead time) is also relevant. Larger the lead time, larger the quantity of material to be stored and larger shall be the amount of working capital required.” |