To know the importance of power factor in an electrical system, first of all we should have the knowledge of some basic terms which are used in an electrical system i.e actual power, reactive power etc.. In an electrical system the power flow has two components, one flow from source to load and able to perform the work at load known as KW or actual power, and the other one is the reactive power which cannot perform any work and it is generated due to the delay between voltage and current known as phase angle. There are one another term is apparent power which are the sum of actual power & reactive power, It is denoted as KVAR. So that we can say that
Apparent Power = Actual Power + Reactive Power
Total KVA = KW + KVAR
Power factor = KW / KVA = KW / (KW+KVAR)
In an ideal system KVAR would be very small and KW and KVA would be almost equal, so we are trying to design an electrical system with power factor 1 than only we are able to get the maximum output from a system. This phenomenon can also be shown as power triangle as below:
 
Where Cos Ɵ  is power factor angle i.e. Cos Ɵ = KW/KVA
 
Reasons of Lower Power Factor:
Since power factor is defined as the ratio of KW to KVA, we see that low power factor results when KW is small in relation to KVA. Now the question arises what causes a large KVAR in a system? The answer is…inductive loads.
Inductive loads (which are sources of Reactive Power) include:
􀂉 Transformers
􀂉 Induction motors
􀂉 Induction generators (wind mill generators)
􀂉 High intensity discharge (HID) lighting
These inductive loads constitute a major portion of the power consumed in industrial complexes. Reactive power (KVAR) required by inductive loads increases the amount of apparent power (KVA) in our distribution system. This increase in reactive and apparent power results in a larger angle θ (measured between KW and KVA). Recall that, as θ increases, cosine θ (or power factor) decreases. So, inductive loads (with large KVAR) result in low power factor.
So there are several reasons due to which, we have to improve our system power factor, some of the benefits are as below:
1) Lower Utility Charges :
a. Reducing Peak KW billing demand
Inductive loads require reactive power, which caused low power factor. This increase in required reactive power (KVAR) causes an increase in required apparent power (KVA), which is what the utility is supplying. So, a facility’s low power factor causes the utility to have to increase its generation and transmission capacity in order to handle this extra demand. By raising power factor, we use less KVAR. This results in less KW, which will help in savings of the utility.
b. Eliminating the power factor penalty
Utilities usually charge customers an additional fee when their power factor is less. Thus, we can avoid this additional fee by increasing our power factor. Now a day’s utilities start the billing in KVAH instead of KWH, this is another reason due to which controlling of power factor is essential.
2) Increased System Capacity and Reduced System Losses in our Electrical System
By adding capacitors (KVAR generators) to the system, the power factor is improved and the KW capacity of the system is increased.
For example, a 1,000 KVA transformer with an 80% power factor provides 800 KW (600 KVAR) of power to the main bus.
1000 KVA = (800 KW)2 + ( ? KVAR)2
KVAR = 600
By increasing the power factor to 90%, more KW can be supplied for the same amount of KVA.
1000 KVA = (900 KW)2 + ( ? KVAR)2
KVAR = 436
The KW capacity of the system increases to 900 KW and the utility supplies only 436 KVAR. Uncorrected power factor causes power system losses in our distribution system. By improving our power factor, these losses can be reduced. With the current rise in the cost of energy, increased efficiency is very desirable, and with lower system losses, we are also able to add additional load to your system.

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