Working Capital Management – Estimation and Calculation
- Blog|Account & Audit|
- 29 Min Read
- By Taxmann
- |
- Last Updated on 27 April, 2023
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“The fact that cash inflows are not matched in both timing and amount by cash outflows, provides us with an operating cycle and rationale for investing in working capital. In any analysis of working capital, a distinction is made between temporary and permanent working capital requirements. The latter are a function of secular and cyclical trends in sales and operating expenses. The former depend on seasonal factors. In a proforma projection of working capital requirements, management must forecast the maximum level of current assets required to support an expected volume of sales and maximum level of short term credit it can anticipate to finance these assets.”1
Refer to Taxmann's Working Capital Management, which aims to fill the gap between theory and practice of working capital management. The finance managers will find the text worthwhile in their pursuit of updating the knowledge about current thinking & developments taking place in the area of working capital management.
Synopsis
1. Estimation Procedure
2. Working Capital as a Percentage of Net Sales
3. Working Capital as a Percentage of Total Assets
4. Working Capital Based on Operating Cycle
-
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- Need for Cash and Bank Balance
- Need for Inventories
- Need for Receivables
- Provided by Creditors
- Provided by Outstanding Wages and Expenses
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5. Estimation of Working Capital Requirement
6. Graded Illustrations in Working Capital Estimation
The efficiency of the planning and management is subject to the correct estimate of the working capital requirement. Irrespective of the planning exercise made and control mechanism adopted, the correct estimation of working capital requirement is the fundamental necessity of a good and efficient working capital management. The present article looks into the steps and calculations required to estimate the working capital requirement for a firm.
1. Estimation Process
A firm must estimate in advance as to how much net working capital will be required for the smooth operations of the business. Only then, it can bifurcate this requirement into permanent working capital and temporary working capital. This bifurcation will help in deciding the financing pattern i.e., how much working capital should be financed from long term sources and how much be financed from short term sources. There are different approaches available to estimate the working capital requirements of a firm as follows :
2. Working Capital as a Percentage of Net Sales
This approach to estimate the working capital requirement is based on the fact that the working capital for any firm is directly related to the sales volume of that firm. So, the working capital requirement is expressed as a percentage of expected sales for a particular period. The working capital estimation is thus, solely dependent on the sales forecast. This approach is Based on the assumption that higher the sales level, the greater would be the need for working capital. There are three steps involved in the estimation of working capital.
(a) To estimate total current assets as a % of estimated net sales.
(b) To estimate current liabilities as a % of estimated net sales, and
(c) The difference between the two above, is the net working capital as a % of net sales.
So, the firm has to find out on the basis of past experience, or on the basis of other firm’s experience in the same competitive environment, as to how much total current assets and total current liabilities should be maintained for a given level of expected sales. The step (a) above i.e., total current assets as a % of net sales will give the gross working capital requirement and step (b) above i.e., current liabilities as a % of net sales will give the funds provided by current liabilities. The difference between the two is the net working capital which the firm has to arrange for. For example, the following information is available for ABC Ltd. for past three years, on the basis of which the working capital requirement for the next year is to be estimated, given that the sales are expected to increase by 10% over sales level of current year.
Year 1 | Year 2 | Year 3 | |
Net Sales | Rs. 10,00,000 | Rs. 12,00,000 | Rs. 14,00,000 |
Total Current Assets | 2,00,000 | 2,52,000 | 3,08,000 |
Total Current Liabilities | 50,000 | 60,000 | 70,000 |
Current Assets as a % of Sales | 20% | 21% | 22% |
Current Liabilities as a % of Sales | 5% | 5% | 5% |
In this case, the average of current assets as a % of sales is 21% i.e., (20%+21%+22%)/3; and the average of current liabilities as a % of sales is 5%. So, the net working capital as a % of sales is 16% i.e., 21%-5%. Now, if the firm expects an increase of 10% in sales next year, then its working capital requirement can be estimated as follows :
Expected Sales = Rs. 14,00,000 + 10% thereof
= Rs. 15,40,000.
Net working capital as a % of sales = 16%.
= Rs. 15,40,000 × 16% = Rs. 2,46,400.
The firm is expected to have gross working capital of Rs. 3,23,400 (i.e., 21% of Rs. 15,40,000) out of which financing by current liabilities is expected to be Rs. 77,000 (i.e., 5% of Rs. 15,40,000). It may be noted that in the above situation the simple arithmetic average of current assets and current liabilities as a % of sales have been taken. If there is a consistent trend (increase or decrease) in current assets or current liabilities or both, then the weighted average may be preferred.
3. Working Capital as a Percentage of Total Assets or Fixed Assets
This approach of estimation of working capital requirement is based on the fact that the total assets of the firm are consisting of fixed assets and current assets. On the basis of past experience, a relationship between (i) total current assets i.e., gross working capital; or net working capital i.e., Current assets – Current liabilities, and (ii) total fixed assets or total assets of the firm is established. For example, a firm is maintaining 20% of its total assets in the form of current assets and expects to have total assets of Rs. 50,00,000 next year. Thus, the current assets of the firm would be Rs. 10,00,000 (i.e., 20% of Rs. 50,00,000).
In this approach, the working capital may also be estimated as a % of fixed assets. The firm basically plans the future level of fixed assets in terms of capital budgeting decisions. In order to use these fixed assets in an efficient and optimal way, the firm must have sufficient working capital. So, the working capital requirement depend upon the planned level of fixed assets. The estimation of working capital therefore, depends upon the estimation of fixed capital which depends upon the capital budgeting decisions. It has already been noted in Chapter 8 that the investment decisions of a firm are consisting of capital budgeting decisions (relating to fixed assets) and working capital management (relating to current assets and current liabilities). So, the working capital estimation, being a part of the investment decisions, should be made together with the capital budgeting decisions.
Both the above approaches to the estimation of working capital requirement are relatively simple in approach but difficult in calculation. The main shortcoming of these approaches is that these require to establish the relationship of current assets with the net sales or fixed assets, which is quite difficult. The past experience either may not be available, or even if available, may not help much in correct estimation. There is yet another approach to estimate the working capital requirement based on the concept of operating cycle.
Working capital requirement of a firm depends upon two variables :
(a) Time Factor
(b) Value Factor
The relevance and use of these two factors is summarised in the Table below:
Elements of Working Capital and Relation with Time & Value Factors
Source Item | Time Factor | Value Factor |
1. Raw Material | Storage Period | Value of Raw Material stored for that period |
2. Work-in- Progress | Production Period (Conversion Period) | Raw Materials consumed + Labour Cost incurred + Manufacturing expenses |
3. Finished Goods | Finished Goods Storage Period | Raw Materials Consumed + Labour Cost incurred + Manu- facturing expenses + Adminis- trative Cost |
4. Debtors | Credit Period Allowed | Raw Materials Consumed + Labour Cost Incurred + Manu- facturing expenses + Adminis- trative Cost |
5. Creditors | Deferral Period Allowed | Value of Raw Materials Purchased in that period. |
6. Labour Cost | Lag Period in Payment | Labour expenses during the lag period |
7. Overhead Expenses | Lag Period in Payment | Overhead expenses during the lag period. |
Both these factors have been considered by operating cycle approach to working capital, and has been discussed below.
Dive Deeper:
What is Capital Budgeting? | Financial Management
4. Working Capital based on Operating Cycle
The concept of operating cycle, as discussed in the preceding chapter, helps determining the time scale over which the current assets are maintained. The operating cycle for different components of working capital gives the time for which an assets is maintained, once it is acquired. However, the concept of operating cycle does not talk of the funds invested in maintaining these current assets. The concept of operating cycle can definitely be used to estimate the working capital requirements for any firm.
In this approach, the working capital estimate depends upon the operating cycle of the firm. A detailed analysis is made for each component of working capital and estimation is made for each of these components. The different components of working capital may be enumerated as follows :
Current Assets | Current Liabilities |
Cash and Bank Balance | Creditors for Purchases |
Inventory of Raw Material | Creditors for Expenses |
Inventory of Work-in-progress | |
Inventory of Finished Goods | |
Receivables |
Different components of current assets require funds depending upon the respective operating cycle and the cost involved. The current liabilities, on the other hand, provide financing depending upon the respective operating cycle or the lag period in payment. The estimation of working capital requirement can now be made as follows :
(a) Need for Cash and Bank Balance : Every firm must maintain some minimum cash and bank balance (i.e., immediate liquidity) to meet day to day requirement for petty expenses, general expenses and even for cash purchases. The minimum cash requirement for these transactions can be estimated on the basis of past experience. The need or motives for holding cash and bank balance have been discussed in detail in the next chapter. However, it must be noted, at this stage that the cash and bank balance must be estimated correctly for two reasons : (i) That the cash and bank balance is the least productive of all the current assets, hence a minimum balance be maintained, and (ii) The cash and bank balance provide liquidity to the firm, which is of utmost importance to any firm. The minimum cash and bank balance is also considered while preparing the cash budget for the firm (Chapter 14).
(b) Need for Raw Materials : Every manufacturing firm has to maintain some stock of raw material in stores in order to meet the requirements of the production process. The number of units to be kept in stores for different types of raw materials depend upon various factors such as raw material consumption rate, time lag in procuring fresh stock, contingencies and other factors. For example, if it takes 5 days to procure fresh stock of raw materials, and 50 units are used daily, then there should be a minimum of 250 units in stock. The firm may also like to have a safety stock of 20 units. Thus, the total units to be maintained in stores would be 270 units. If the cost per unit of this item of raw material is Rs. 10 per unit, then the working capital requirement is Rs. 2,700 (i.e., 270 × Rs. 10).
(c) Need for Work-in-progress : In any manufacturing firm, the production process is continuous and is generally consisting of several stages. At any particular point of time, there will be different number of units in different stages of production. Some of these units may be 10% complete, some may be 60% complete and some may be even 99% complete. These units, which can neither be defined as raw material nor as finished goods, are known as work-in-progress or semi-finished goods. The value of raw material, wages and other expenses locked up in these semi-finished units is the working capital requirement for work-in-progress.
It may be noted that all the units are not equally completed and hence valuation of all these units is a difficult job. For this purpose, certain assumptions may be made as follows :
(i) The production process starts with the intake of full raw material. So, the value of raw material locked up in work-in-progress will be equal to full cost of number of units of raw material being represented in work-in-progress.
(ii) The units in work-in-progress may be unfinished with respect to labour expenses and overhead expenses only. Some of these units may be 10% complete, some may be 75% complete and some may be even 80% complete and so on. It is assumed for simplification, that all work-in-progress units are on an average 50% complete with respect to labour and overhead expenses. However, if some other information is given, then the valuation of work-in-progress may be made accordingly.
(d) Need for Finished Goods : In most of the cases, be it a trading concern or a manufacturing concern, the goods are not immediately sold after purchase/procurement/completion of production process. The goods in fact, remain in stores for some times before they are sold. The cost which is already incurred in purchasing, procuring or production of these units is locked up and hence working capital is required for them. It may be noted that these finished goods are valued on the basis of cost of these units. The carriage inward ofcourse, is included.
(e) Need for Receivables : The term receivables include the debtors and the bills. When the goods are sold by a firm on cash basis, the sales revenue is realized immediately and no working capital is required for after sale period. However, in case of credit sales, there is a time lag between sales and collection of sales revenue. For example, a firm makes a credit sale of Rs. 1,50,000 per month and a credit of 15 days given to customers. The working capital locked up in receivables is Rs. 75,000 (Rs. 1,50,000 × 1/2 month).
However, an important point is worth noting here. The calculation of Rs. 75,000 is based upon the selling price, whereas the actual funds locked up in receivables are restricted to the cost of goods sold only. There is no investment in profit element as such. Therefore, it is better to calculate the working capital locked up in receivables on the cost basis. Thus, if the firm is selling goods at a gross profit of 20% then the working capital requirement in the above case, for receivables would be Rs. 60,000 only (i.e., Rs. 75,000 × 80%).
The total of working capital requirement for all the above elements is also known as the gross working capital of the firm. At any particular point of time every firm requires this gross working capital as there will be some units of raw materials in stores, some units in work-in-progress, some units as finished goods and there will be some debtors yet to be collected.
(f) Creditors for the Purchases : Likewise a firm sells goods and services on credit it may procure/purchases raw materials and finished goods on credit basis. The payment for these purchases may be postponed for the period of credit allowed by suppliers. So, the suppliers of the firm in fact provide working capital to the firm for the credit period. For example, a firm makes credit purchases of Rs. 60,000 per month and the credit allowed by the suppliers is two month, then the working capital supplied by the creditors is Rs. 1,20,000 (i.e., Rs. 60,000×2 months). It means that the firm would be getting the supplies without however, making the payment for two months. The postponement of the payment to the creditors makes the firm to utilize this money elsewhere or help the firm to sell on credit without blocking its own funds.
(g) Creditors for Expenses and Wages : Usually, the expenses and wages are paid at the end of a month. However, these wages and expenses accumulate in the work-in-progress and finished goods on a regular basis. The time lag in payment of wages and other expenses also provide some working capital to the firm. It may be noted that these wages and expenses are considered for the valuation of work-in-progress and finished goods, but are paid usually at the end of the month, providing a working capital to the firm for that period.
The working capital estimation as per the method of operating cycle, is the most systematic and logical approach. In this case, the working capital estimation is made on the basis of analysis of each and every component of the working capital individually. As already discussed, the working capital, required to sustain the level of planned operations, is determined by calculating all the individual components of current assets and current liabilities. There are different steps required for estimation of working capital based on operating cycle. These steps are :
(i) Identify the current assets and current liabilities to be maintained. Estimation of each element of current assets and current liability is required.
(ii) Determine the average operating cycle (or holding period) for each of these elements. Calculation of different holding periods has been explained in the previous chapter.
(iii) Find out the rate per unit for each of these elements. For example, the rates of raw materials, work in progress, finished goods are to be ascertained.
(iv) Find out the amount (funds) expected to be blocked in each of these elements. For example, in raw materials, the funds blocked are :
Av. holding period × No. of units required Per Period × Rate per unit.
(v) Prepare the working capital estimation sheet and find out the working capital requirement.
The calculation of net working capital may also be shown as follows :
Working Capital | = Current Assets – Current Liabilities |
= (Raw Material Stock + Work-in- progress Stock + Finished Goods Stock + Debtors + Cash Balance) – (Credi- tors + Outstanding Wages + Outstanding Overheads), | |
where, Raw Material Stock |
= Cost (Average) of Materials in Stock. |
Work-in-progress Stock | = Cost of Materials + Wages + Overhead of Work-in-progress. |
Finished Goods Stock Creditors for Material | = Cost of Materials + Wages + Overhead of Finished Goods. |
Creditors for Materials | = Cost of Average Outstanding Creditors. |
Creditors for Wages | = Average Wages Outstanding. |
Creditors for Overhead | = Average Overheads Outstanding. |
Thus, Working Capital | = Cost of Materials in Stores, in Work-in-progress, in Finished Goods and in Debtors.
Less : Creditors for Materials Plus : Wages in Work-in-progress, in Finished Goods and in Debtors. Less : Creditors for Wages. Plus : Overheads in Work-in-progress, in Finished Goods and in Debtors. Less : Creditors for Overheads. |
The work-sheet for estimation of working capital requirements under the operating cycle method may be presented as follows :
5. Estimation of Working Capital Requirements
I | Current Assets : | Amount | Amount | Amount |
Minimum Cash Balance | **** | |||
Inventories : | ||||
Raw Materials | **** | |||
Work-in-progress | **** | |||
Finished Goods | **** | **** | ||
Receivables : | ||||
Debtors | **** | |||
Bills | **** | **** | ||
Gross Working Capital (CA) | **** | **** | ||
II. | Current Liabilities : | |||
Creditors for Purchases | **** | |||
Creditors for Wages | **** | |||
Creditors for Overheads | **** | |||
Total Current Liabilities (CL) | **** | **** | ||
Excess of CA over CL | **** | |||
+ Safety Margin | **** | |||
Net Working Capital | **** |
The following points are also worth noting while estimating the working capital requirement :
-
- Depreciation : An important point worth noting while estimating the working capital requirement is the depreciation on fixed assets. The depreciation on the fixed assets, which are used in the production process or other activities, is not considered in working capital estimation. The depreciation is a non-cash expense and there is no funds locked up in depreciation as such and therefore, it is ignored. Depreciation is neither included in valuation of work-in-progress nor in finished goods. The working capital calculated by ignoring depreciation is known as cash basis working capital. In case, depreciation is included in working capital calculations, such estimate is known as total basis working capital.
- Safety Margin : Sometimes, a firm may also like to have a safety margin of working capital in order to meet any contingency. The safety margin may be expressed as a % of total current assets or total current liabilities or net working capital. The safety margin, if required, is incorporated in the working capital estimates to find out the net working capital required for the firm. There is no hard and fast rule about the quantum of safety margin and depends upon the nature and characteristics of the firm as well as of its current assets and current liabilities.
6. Points to Remember
-
- Every firm must estimate in advance as to how much net working capital will be required for the smooth operations of the business.
- Working capital estimates may be made on the basis of (i) As a % of net sales, (ii) As a % of total assets or fixed assets and (iii) operating cycle of the firm.
- In the operating cycle method, the working capital requirement is ascertained by finding out the need for cash, for raw materials, for work in progress, for finished goods and for debtors. However, if the credit is allowed by creditors or others then it is deducated to find out the net working capital requirement.
- At the work in progress stage, the three elements is RM, wages and expenses are estimated separately.
- Unless given otherwise, 100% RM is assumed to introduced in the production process in the beginning, but wages and expenses are assumed to accrue evenly throughout the production process.
- The requirement for finished goods and work in progress is taken at cash cost only and the amount of depreciation is ignored.
- The debtors (receivables) may be taken at cash cost or selling price. But it is better to take the debtors at cash cost because that shows the funds required for financing of working capital.
- While finding out the working capital requirement, the firm should also include a safety margin to take care of the contingencies.
7. Graded Illustrations
Illustration A
ABC Ltd. expects its cost of goods sold for 2000-2001 to be Rs. 600 lacs. The expected operating cycle is 90 days. It wants to keep a minimum cash balance of Rs. one lac. What is the expected working capital requirement? Assume a year consists of 360 days.
Solution :
Working Capital Requirement:
Cash balance | = | Rs. 1,00,000 | |
Working Capital for Cost of goods sold | = | 600,00,000 | × 90 |
360 | |||
= | Rs. 150,00,000 | ||
Total Working Capital | = | Rs. 151,00,000 |
Illustration B
Find out the working capital requirement from the following information : | |
Production during the year | 60,000 units |
Selling Price | Rs. 5 per unit. |
Raw Material | 60% |
Wages | 10% |
Overheads | 20% |
Raw Material storage period | 2 months |
Work in process storage period | 1 months |
Finished goods storage period | 3 months |
Credit allowed by suppliers | 2 months |
Credit allowed to customers | 3 months |
Minimum cash balance desired | Rs. 20,000 |
Wages and overheads payment | 1 month |
Solution:
Production per month | (60,000÷12) | 5,000 units |
Selling Price | Rs. 5.00 per unit | |
Raw Material | (60%) | Rs. 3.00 per unit |
Wages | (10%) | Rs. 0.50 per unit |
Overheads | (20%) | Rs. 1.00 per unit |
Estimation of working capital requirement
I. Current Assets: | Amount | Amount | |
Cash Balance | Rs. 20,000 | ||
Raw Material | (5,000 × Rs. 3 × 2) | 30,000 | |
Work in Process: | |||
Raw Material | (5000 × Rs 3 × 1) | 15,000 | |
Wages | (5000 × Rs. 0.50 × 1)50% | 1,250 | |
Overheads | (5,000 × Rs. 1 × 1)50% | 2,500 | |
Finished good | (5000 × Rs. 4.50 × 3) | 67,500 | |
Debtors | (5,000 × Rs. 4.50 × 3) | 67,500 | |
Gross Working Capital | 2,03,750 | Rs. 2,03,750 | |
II. Current Liabilities : | |||
Creditors | (5,000 × Rs. 3 × 2) | 30,000 | |
Wages | (5,000 × Rs. 0.50 × 1) | 2,500 | |
Overheads | (5,000 × Rs. 1 × 1) | 5,000 | |
Total Current Liabilities | 37,500 | 37,500 | |
Net Working Capital | (CA–CL) | 1,66,250 |
Illustration C
Prepare an estimate of networking capital requirement of Zero company from the data given below:
Estimated Cost per Unit of Production | Amount per Unit (Rs. ) | |
Raw Materials | 100 | |
Direct Labour | 40 | |
Overheads | 80 | |
220 |
The following is the additional information:
Selling price per unit | Rs. 240 |
Level of activity | 1,04,000 units per annum |
Raw Materials in stock | average 4 weeks |
Work in progress [Assume 100% stage of completion of materials and 50 per cent for labour and overheads] | average 2 weeks |
Finished Goods in Stock | average 4 weeks |
Credit allowed by Suppliers | average 4 weeks |
Credit allowed to Debtors | average 8 weeks |
Lag in payment of Wages | average 1 1/2 weeks. |
Cash at Bank is expected to be Rs. 25,000. Assume that production is sustained during 52 weeks of the year.
Solution:
Statement of working capital requirement
A. | Current Assets | Amount (Rs. ) | Amount (Rs. ) | ||
Raw Materials | (2000 × 4 × 100) | 8,00,000 | |||
Work in Progress | |||||
Raw Material | (2000 × 2 × 100) | 4,00,000 | |||
Wages | (2000 × 2 × 40) 50% | 80,000 | |||
Overheads | (2000 × 2 × 80) 50% | 1,60,000 | 6,40,000 | ||
Finished Stock | (2000 × 4 × 220) | 17,60,000 | |||
Debtors | (2000 × 8 × 220) | 35,20,000 | |||
Cash | 25,000 | ||||
Total Current Assets (CA) | 67,45,000 | ||||
B. | Current Liabilities | ||||
Creditors | (2000 × 4 × 100) | 8,00,000 | |||
Outstanding Wages | (2000 × 40 × 1.5) | 1,20,000 | |||
Total Current Liabilities (CL) | 9,20,000 | ||||
Net Working Capital (CA–CL) | 58,25,000 |
Working Notes:
(i) Annual production is 1,04,000 units and year is consisting of 52 weeks. So, the weekly production is 2000 units.
(ii) Debtors have been taken at cost of production.
Illustration D
The cost sheet of PQR Ltd. provides the following data :
Cost per unit | |
Raw material | Rs. 50 |
Direct Labour | 20 |
Overheads (including depreciation of Rs. 10) | 40 |
Total cost | 110 |
Profits | 20 |
Selling price | 130 |
Average raw material in stock is for one month. Average material in work-in-progress is for half month. Credit allowed by suppliers: one month; credit allowed to debtors : one month. Average time lag in payment of wages: 10 days; average time lag in payment of overheads 30 days. 25% of the sales are on cash basis. Cash balance expected to be Rs. 1,00,000. Finished goods lie in the warehouse for one month.
You are required to prepare a statement of the working capital needed to finance a level of the activity of 54,000 units of output. Production is carried on evenly throughout the year and wages and overheads accrue similarly. State your assumptions, if any, clearly.
Solution :
As the annual level of activity is given at 54,000 units, it means that the monthly turnover would be 54,000/12 = 4,500 units. The working capital requirement for this monthly turnover can now be estimated as follows :
Estimation of Working Capital Requirement
I. | Current Assets : | Amount | Amount |
Minimum Cash Balance | Rs. 1,00.000 | ||
Inventories : | |||
Raw Materials (4,500 × Rs. 50) | 2,25,000 | ||
Work-in-progress : | |||
Materials (4,500 × Rs. 50)/2 | 1,12,500 | ||
Wages 50% of (4,500 × Rs. 20)/2 | 22,500 | ||
Overheads 50% of (4,500 × Rs. 30)/2 | 33,750 | ||
Finished Goods (4,500 × Rs. 100) | 4,50,000 | ||
Debtors (4,500 × Rs. 100 × 75%) | 3,37,500 | ||
Gross Working Capital | 12,81,250 | Rs. 12,81,250 | |
II. | Current Liabilities : | ||
Creditors for Materials (4,500 × Rs. 50) | 2,25,000 | ||
Creditors for Wages (4,500 × Rs. 20)/3 | 30,000 | ||
Creditors for Overheads (4,500 × Rs. 30) | 1,35,000 | ||
Total Current Liabilities | 3,90,000 | 3,90,000 | |
Net Working Capital | 8,91,250 |
Working Notes :
-
- The Overheads of Rs. 40 per unit include a depreciation of Rs. 10 per unit, which is a non-cash item. This depreciation cost has been ignored for valuation of work-in-progress, finished goods and debtors. The overhead cost, therefore, has been taken only at Rs. 30 per unit.
- In the valuation of work-in-progress, the raw materials have been taken at full requirements for 15 days; but the wages and overheads have been taken only at 50% on the assumption that on an average all units in work-in-progress are 50% complete.
- Since, the wages are paid with a time lag of 10 days, the working capital provided by wages has been taken by dividing the monthly wages by 3 (assuming a month to consist of 30 days).
Illustration E
The following information has been extracted from the records of a Company : Product cost sheet
Raw Materials | Rs. 45 | |
Direct Labour | 20 | |
Overheads | 40 | |
Total | 105 | |
Profit | 15 | |
Selling price | 120 |
– Raw materials are in stock on an average for two months.
– The materials are in process on an average for one month. The degree of completion is 50% in respect of all elements of cost.
– Finished goods stock on an average is for one month.
– Time lag in payment of wages and overheads is 1½ weeks.
– Time lag in receipt of proceeds from debtors is 2 months.
– Credit allowed by suppliers is one month.
– 20% of the output is sold against cash.
– The company expects to keep a Cash balance of Rs. 1,00,000.
The Company is poised for a manufacture of 1,44,000 units in the next year.
You are required to prepare a statement showing the Working Capital requirements of the Company
Solution :
Statement showing the Working Capital requirement of the Company
Current Assets : | ||
Stock of Raw Materials (12,000 × 2 × Rs. 45) | Rs. 10,80,000 | |
Work-in-progress (12,000 × 1 × Rs. 105) × 50% | 6,30,000 | |
Finished Goods (12,000 × 1 × Rs. 105) | 12,60,000 | |
Debtors (12,000 × 2 × Rs. 105 × 80%) | 20,16,000 | |
Cash balances | 1,00,000 | 50,86,000 |
Current Liabilities : | ||
Creditors of Raw Materials (12,000 × 1 × Rs. 45) | 5,40,000 | |
Creditors for Wages & Overheads (12,000 × 60 ÷ 4) 1.5 | 2,70,000 | 8,10,000 |
Net Working capital (C.A – C.L) | 42,76,000 |
Working Notes :
-
- Finished goods and Debtors have been taken at cost.
- Production per month has been taken at 12,000 units. For payment of wages and overheads, month is taken as consisting of 4 weeks.
Illustration F
XYZ Ltd. supplied the following information:
Sales and Production for the year | 69,000 units |
Finished goods in store | 3 months |
Raw material in store | 2 months consumption |
Production process | 1 month |
Credit allowed by creditors | 2 months |
Selling price per unit | Rs. 50.00 |
Raw material | 50% of Selling Price |
Direct wages | 10% of Selling Price |
Overheads | 20% of Selling Price |
20% Sales are on cash basis and credit sales allowed to customers for one month. Overheads include Rs. 5 as depreciation. There is regular production and Sale cycle and wages and overheads accrue evenly. Wages are paid in the next month of accrual and overheads are paid 15 days in arrears. Material is introduced in the beginning of Production cycle. You are required to find out its working capital requirement on cash cost basis.
[B.Com.(H.), D.U., 2014]
Solution :
Statement of Working Capital Requirement
I. | Current Assets : | |
Raw Material (5,750×25×2) | Rs. 2,87,500 | |
Work-in-Progress (5,750×25×1) | 1,43,750 | |
Wages (5750×5×1) 50% | 14,375 | |
OH (5,750×5×1) 50% | 14,375 | |
Finished Goods (5,750×35×1) | 6,03,750 | |
Debtors (5,750×35×1) 80% | 1,61,000 | |
Total current Assets | 12,24,750 | |
II. | Current Liabilities: | |
Creditors (5,750×25×2) | Rs. 2,87,500 | |
Wages (5,750×5×1) | 28,750 | |
Overheads (5,750×5×1) | 14,375 | |
Total Current Liabilities | 3,30,625 | |
Net Working Capital (CA–CL) | Rs. 8,94,125 | |
Working Notes: | ||
Monthly Production (6,90,000/12) | 5,750 units | |
Selling price | Rs. 50 | |
Raw Material(50%) | Rs. 25 | |
Direct wages (10%) | Rs. 5 | |
Overheads (20%) | Rs. 10 | |
Cash cost (Rs. 25+5+5) | Rs. 35 |
Illustration G
Following Information is provided by ABC Ltd. :
Raw Material Storage Period | 50 days |
Work in Progress Storage Period | 18 days |
Finished Goods Storage Period | 22 days |
Debt Collection Period | 45 days |
Creditors Payment Period | 55 days |
Annual Operating Cost (including Depreciation of Rs. 2,10,000) | Rs. 21 lacs |
Days in a year | 360 |
Find out : (i) Operating Cycle Period, (ii) No. of Operating Cycles in a year, and (iii) Working Capital Requirement on cash cost basis.
Solution :
Operating Cycle Period :
OC = RMCP + WPCP + FGCP + RCP – DP
= 50 + 18 + 22 + 45 – 55
= 80 days
No. of Operating Cycle in a year :
No. of Cycles = 360 ÷ Length of OC
= 360 ÷ 80 = 4.5 Cycles
Working Capital Requirement :
Requirement per day | = | Total Cost (Cash) | |
360 |
= | Rs. 21,00,000 – Rs. 2,10,000 | ||
360 | |||
= | Rs. 5,250 |
Working Capital Requirement = OC × Requirement per day
= Rs. 5,250 × 80
= Rs. 4,20,000
Illustration H
Prepare an estimate of net working capital requirement for the WCM Ltd. adding 10% for contingencies from the information given below :
Estimated cost per unit of production Rs. 170 includes raw materials Rs. 80, direct labour Rs. 30 and overheads (exclusive of depreciation) Rs. 60. Selling price is Rs. 200 per unit. Level of activity per annum 1,04,000 units. Raw material in stock : average 4 weeks; work-in-progress (assume 50% completion stage): average 2 weeks; finished goods in stock : average 4 weeks; credit allowed by suppliers : average 4 weeks; credit allowed to debtors: average 8 weeks; lag in payment of wages : average 1.5 weeks, and cash at bank is expected to be Rs. 25,000. You may assume that production is carried on evenly throughout the year (52 weeks) and wages and overheads accrue similarly. All sales are on credit basis only. You may state your assumptions, if any.
Solution :
Statement of Net Working Capital Requirement
A. | Current Assets : | ||
(i) Raw Materials in stock : | (1,04,000 × 80 × 4)/52 | Rs. 6,40,000 | |
(ii) Work-in-progress : | |||
(a) Raw Materials | (1,04,000 × 80 × 2)/52 | 3,20,000 | |
(b) Direct Labour | 50% of (1,04,000 × 30 × 2)/52 | 60,000 | |
(c) Overheads | 50% of (1,04,000 60 × 2)/52 | 1,20,000 | |
(iii) Finished Goods Stock | (1,04,000 × 170 × 4)/52 | 13,60,000 | |
(iv) Debtors | (1,04,000 × 170 × 8)/52 | 27,20,000 | |
(v) Cash at Bank | 25,000 | ||
Total Current Assets | 52,45,000 | ||
B. | Current Liabilities : | ||
(i) | Creditors | (1,04,000 × 80 × 4)/52 | 6,40,000 |
(ii) | Wages (Lag-in-payment) : | (1,04,000 × 30 × 1½)/52 | 90,000 |
Total current liabilities | 7,30,000 | ||
Net Working Capital (CA – CL) | 45,15,000 | ||
+10% Contingencies | 4,51,500 | ||
Working Capital Requirement | 49,66,500 |
Assumptions : Net working capital requirement has been estimated on cash cost basis. Hence, investment in debtor has been computed on cash cost.
Illustration I
The management of Royal Industries has called for a statement showing the working capital to finance a level of activity of 1,80,000 units of output for the year. The cost structure for the company’s product for the above mentioned activity level is detailed below :
Cost per unit | |
Raw Material | Rs. 20 |
Direct Labour | 5 |
Overheads (including depreciation of Rs. 5 per unit) | 15 |
40 | |
Profit | 10 |
Selling price | 50 |
Additional information :
(a) Minimum desired cash balance is Rs. 20,000.
(b) Raw materials are held in stock, on an average, for two months.
(c) Work-in-progress (assume 50% completion stage in respect of all elements) will approximate to half-a-month’s production.
(d) Finished goods remain in warehouse, on an average, for a month.
(e) Suppliers of materials extend a month’s credit and debtors are provided two month’s credit; cash sales are 25% of total sales.
(f) There is a time-lag in payment of wages of a month; and half-a-month in the case of overheads.
From the above facts, you are required to prepare a statement showing working capital requirements.
Solution :
Statement of Total Cost
Raw Material (1,80,000 × Rs. 20) | Rs. 36,00,000 | |
Direct Labour (1,80,000 × Rs. 5) | 9,00,000 | |
Overheads (excluding depreciation) (1,80,000 × Rs. 10) | 18,00,000 | |
Total cost | 63,00,000 |
Statement of Working Capital Requirement
1. | Current Assets : | Amt. (Rs. ) |
Cash balance | 20,000 | |
Raw Materials (1/6 of Rs. 36,00,000) | 6,00,000 | |
Work-in-progress (Total cost ÷ 24 × 50%) | 1,31,250 | |
Finished Goods (Total cost ÷ 12) | 5,25,000 | |
Debtors (75% × Rs. 63,00,000) × 1/6 | 7,87,500 | |
Total current assets | 20,63,750 | |
2. | Current Liabilities : | |
Creditors (Rs. 36,00,000) × 1/12 | 3,00,000 | |
Direct labour (Rs. 9,00,000) × 1/12 | 75,000 | |
Overheads (Rs. 18,00,000) × 1/24 (excluding dep.) | 75,000 | |
Total current liabilities | 4,50,000 | |
Net working capital requirement | 16,13,750 |
Note : Depreciation is a non-cash item, therefore, it has been excluded from total cost as well as working capital provided by overheads. Work-in-progress has been assumed to be 50% complete in respect of materials as well as labour and overheads expenses.
Illustration J
Hi-tech Ltd. plans to sell 30,000 units next year. The expected cost of goods sold is as follows :
Rs. (Per Unit) | |
Raw Material | 100 |
Manufacturing expenses | 30 |
Selling, administration and financial expenses | 20 |
Selling price | 200 |
The duration at various stages of the operating cycle is expected to be as follows :
Raw Material stage | 2 months |
Work-in-progress stage | 1 month |
Finished stage | 1/2 month |
Debtors stage | 1 month |
Assuming the monthly sales level of 2,500 units, estimate the gross working capital requirement if the desired cash balance is 5% of the gross working capital requirement, and work-in-progress is 25% complete with respect to manufacturing expenses. [B.Com. (H.), D.U., 2013 Adapted]
Solution :
Statement of Working Capital Requirement
Current Assets : | Amt.(Rs. ) | Amt.(Rs. ) |
Stock of Raw Material (2,500 × 2 × 100) | 5,00,000 | |
Work-in-progress : | ||
Raw Materials (2,500 × 100) | 2,50,000 | |
Manufacturing Expense 25% of (2,500 × 30) | 18,750 | 2,68,750 |
Finished Goods : | ||
Raw Material (2,500 × 1/2 × 100) | 1,25,000 | |
Manufacturing Expenses (2,500 × ½ × 30) | 37,500 | 1,62,500 |
Debtors (2,500 × 150) | 3,75,000 | |
13,06,250 | ||
Cash Balance (13,06,250 × 5/95) | 68,750 | |
Working Capital Requirement | 13,75,000 |
Note: Selling, administration and financial expenses have not been included in valuation of closing stock. However, Debtors have been valued at full cost. Alternatively, Debtors can also be valued at Rs. 30.
Illustration K
Calculate the amount of working capital requirement for SRCC Ltd. from the following information:
Rs. (Per Unit) | |
Raw Material | 160 |
Direct Labour | 60 |
Overheads | 120 |
Total cost | 340 |
Profit | 60 |
Selling price | 400 |
Raw materials are held in stock on an average for one month. Materials are in process on an average for half-a-month. Finished goods are in stock on an average for one month.
Credit allowed by suppliers is one month and credit allowed to debtors is two months. Time lag in payment of wages is 1½ weeks. Time lag in payment of overhead expenses is one month. One fourth of the sales are made on cash basis.
Cash in hand and at the bank is expected to be Rs. 50,000 : and expected level of production amounts to 1,04,000 units for a year of 52 weeks.
You may assume that production is carried on evenly throughout the year and a time period of four weeks is equivalent to a month.
Solution :
Statement of Working Capital Requirement
1. | Current Assets : | Amount | Amount |
Cash Balance | Rs. 50,000 | ||
Stock of Raw Material (2,000 × 160 × 4) | 12,80,000 | ||
Work-in-progress : | |||
Raw Materials (2,000 × 160 × 2) | Rs. 6,40,000 | ||
Labour and Overheads (2,000 × 180 × 2) × 50% | 3,60,000 | 10,00,000 | |
Finished Goods (2,000 × 340 × 4) | 27,20,000 | ||
Debtors (2,000 × 75% × 340 × 8) | 40,80,000 | ||
Total Current Assets | 91,30,000 | ||
2. | Current Liabilities : | ||
Creditors (2,000 × Rs. 160 × 4) | 12,80,000 | ||
Creditors for Wages (2,000 × Rs. 60 × 1½) | 1,80,000 | ||
Creditors for Overheads (2,000 × Rs. 120 × 4) | 9,60,000 | ||
Total Current Liabilities | 24,20,000 | ||
Net Working Capital (CA – CL) | 67,10,000 |
Illustration L
The data of ABC Ltd. is as under:
Production of the year | : | 69,000 units |
Finished Goods inventory | : | 3 months |
Raw Materials inventory | : | 2 months consumption |
Production process | : | 1 month |
Credit allowed by Creditors | : | 2 months |
Credit given to Debtors | : | 3 months |
Selling Price per unit | : | Rs. 50 each |
Raw Material | : | 50% of selling price |
Direct Wages | : | 10% of selling price |
Overheads | : | 20% of selling price |
There is a regular production on sales cycle, wages and overheads accrue evenly. Wages are paid in the next month of accrual. Material is introduced in the beginning of production cycle. Work-in-process involves use of full unit of raw materials in the beginning of manufacturing process and other conversion costs equivalent to 50%.
You are required to find out working capital requirement of ABC Ltd.
[B.Com. (H.), D.U., 2010]
Solution :
Monthly Production (69000 ÷ 12) = 5750
Statement of Working Capital Requirement
I. Current Assets: | ||||
RM (5,750 × 2 × 25) | Rs. 2,87,500 | |||
WIP | – | RM (5,750 × 1 × 25) | 1,43,750 | |
– | W (5,750 × 1 × 5) 50% | 14,375 | ||
– | O/H (5,750 × 1 × 10) 50% | 28,750 | ||
FG (5,750 × 3 × 40) | 6,90,000 | |||
Debtors (5,750 × 3 × 40) | 6,90,000 | Rs. 18,54,375 | ||
II. Current Liabilities: | ||||
Creditors (5,750 × 2 × 25) | 2,87,500 | |||
Wages (5,750 × 1 × 5) | 28,750 | 3,16,250 | ||
Working Capital Requirement (CA – CL) | 15,38,125 |
Illustration M
Prepare a working capital forecast from the following information :
Production during the previous year was 10,00,000 units. The same level of activity is intended to be maintained during the current year. The expected ratios of cost to selling price are :
Raw materials | 40% |
Direct Wages | 20% |
Overheads | 20% |
The raw materials ordinarily remain in stores for 3 months before production. Every unit of production remains in the process for 2 months and is assumed to be consisting of 100% raw material, wages and overheads. Finished goods remain in the warehouse for 3 months. Credit allowed by creditors is 4 months from the date of the delivery of raw material and credit given to debtors is 3 months from the date of dispatch.
The estimated balance of cash to be held Rs. 2,00,000
Lag in payment of wages ½ month
Lag in payment of expenses ½ month
Selling price is Rs. 8 per unit. You are required to make a provision of 10% for contingency (except cash). Relevant assumptions may be made.
Solution :
Total Sales = 10,00,000 × 8 = Rs. 80,00,000
Statement of Working Capital Requirement
A. | Current Assets : | ||
Debtors (80,00,000 × 80% × 3/12) | Rs. 16,00,000 | ||
Finished Goods (80,00,000 × 80% × 3/12) | 16,00,000 | ||
Work-in-progress (80,00,000 × 80% × 2/12) | 10,66,667 | ||
Raw Materials (80,00,000 × 40% × 3/12) | 8,00,000 | ||
Total current assets | 50,66,667 | Rs. 50,66,667 | |
B. | Current Liabilities : | ||
Creditors (80,00,000 × 40% × 4/12) | 10,66,667 | ||
Wages (80,00,000 × 20% × 1/24) | 66,667 | ||
Overheads (80,00,000 × 20% × 1/24) | 66,666 | 12,00,000 | |
Excess of CA over CL | 38,66,667 | ||
+ 10% contingency | 3,86,667 | ||
42,53,334 | |||
Cash | 2,00,000 | ||
Working Capital Requirement | 44,53,334 |
Illustration N
AB Ltd. provides the following particulars relating to its working:
(i) | Cost/Profit per unit: | |
Raw Material Cost | Rs. 84 | |
Direct Labour Cost | 36 | |
Overheads (All Variable) | 36 | |
Total Cost | 156 | |
Profit | 44 | |
Selling Price | 200 | |
(ii) | Average Amount of Back up Stock : | |
Raw Material | 1 month | |
Work-in-Progress (50% Complete) | ½ month | |
Finished Goods | 1 month | |
(iii) | Credit allowed by Suppliers | 1 month |
(iv) | Credit allowed to Customers | 2 month |
(v) | Average time lag in the payment of: | |
Wages | ½ month | |
Overhead Expenses | 1½ months | |
(vi) | Required Cash in hand and at Bank Rs. 3,00,000. | |
(vii) | 25% of the output is sold for cash. |
For an expected annual sale of 1,00,000 units, work out the working capital requirement assuming that production is carried on evenly throughout the year and wages and overheads accrue similarly.
Solution:
Statement of working capital requirement
- Current Assets:
Cash | Rs. 3,00,000 | |
Raw Material (1,00,000 × 84) ÷ 12 | 7,00,000 | |
Work in Progress: | ||
Raw Material (1,00,000 × 84) ÷ 24 | Rs. 3,50,000 | |
Labour [(1,00,000 × 36) ÷ 24)] 50% | 75,000 | |
Overhead [(1,00,000 × 36) ÷ 24)] 50% | 75,000 | 5,00,000 |
Finished Goods (1,00,000 × 156) ÷ 12 | 13,00,000 | |
Debtors (1,00,000 × 75% × 156) ÷ 6 | 19,50,000 | |
Total Current Assets (CA) | 47,50,000 | |
II Current Liabilities : | ||
Creditors (1,00,000 × 84) ÷ 12 | 7,00,000 | |
O/S Wages (1,00,000 × 36) ÷ 24 | 1,50,000 | |
O/S Overheads (1,00,000 × 36) ÷ 12] × 1.5 | 4,50,000 | |
Total Current Liabilities (CL) | 13,00,000 | |
Net Working Capital Requirement (CA – CL) | 34,50,000 |
Illustration O
Grow More Ltd. is presently operating at 60% level, producing 36,000 units per annum. In view of favourable market conditions, it has been decided that from 1st January 2014, the Company would operate at 90% capacity The following informations are available :
(i) Existing cost-price structure per unit is given below :
Raw Material | Rs. 4.00 |
Wages | 2.00 |
Overheads (Variable) | 2.00 |
Overheads (Fixed) | 1.00 |
Profits | 1.00 |
(ii) It is expected that the cost of raw material, wages rate, expenses and sales per unit will remain unchanged in 2000.
(iii) Raw materials remain in stores for 2 months before these are issued to production. These units remain in production process for 1 month.
(iv) Finished goods remain in godown for 2 months.
(v) Credit allowed to debtors is 2 months. Credit allowed by creditors is 3 months.
(vi) Lag in wages and overhead payments is 1 month. It may be assumed that wages and overhead accrue evenly throughout the production cycle.
You are required to :
(a) Prepare profit statement at 90% capacity level; and
(b) Calculate the working requirements on an estimated basis to sustain the increased production level.
Assumptions made if any, should be clearly indicated.
Solution :
Statement of Profitability at 90% Capacity
Units (at 90% capacity) | 54,000 |
Sales (54,000 × Rs. 10) (A) | Rs. 5,40,000 |
Cost : | |
Raw Material (54,000 × Rs. 4) | 2,16,000 |
Wages (54,000 × Rs. 2) | 1,08,000 |
Variable Overheads (54,000 × Rs. 2) | 1,08,000 |
Fixed Overheads (Rs. 1 × 36,000) | 36,000 |
Total cost (B) | 4,68,000 |
Net profit (A–B) | 72,000 |
Statement of Working Capital Requirement
A. | Current Assets | ||
Stock of Raw Materials (2 months × 4,500 × Rs. 4) | Rs. 36,000 | ||
Work-in-progress : | |||
Materials (1 month × 4,500 × Rs. 4) | Rs. 18,000 | ||
Wages (1/2 month) | 4,500 | ||
Overheads (1/2 month) | 6,000 | 28,500 | |
Finished Goods (2 month) | 78,000 | ||
Debtors [2 months × (4,68,000/12)] | 78,000 | ||
Total Current Assets | 2,20,500 | ||
B. | Current Liabilities | ||
Sundry Creditors (3 months) | 54,000 | ||
Outstanding Wages (1 month) | 9,000 | ||
Outstanding Overhead (1 month) | 12,000 | ||
Total Current Liabilities | 75,000 | ||
Working Capital Requirement (CA – CL) | 1,45,500 |
Working Note :
Overheads and Wages : The work in progress period is one month. So, the wages and overheads included in work-in-progress, are on an average, for half month or 1/24 of a year.
Wages | = | Rs. 1,08,000 | = Rs. 4,500 | |
24 | ||||
Overheads | = | Rs. 1,08,000 + 36,000 | = Rs. 6,000 | |
24 |
The valuation of finished goods can also be arrived at as follows :
Number of units | = | 4,500 × 2 = 9,000 |
Variable cost | = | Rs. 8 per unit |
Fixed cost (Rs. 36,000/12) × 2 | = | Rs. 6,000 |
Total cost of finished goods (9,000 × 8) + 6,000 | = | Rs. 78,000 |
As the decision to increase the operating capacity from 60% to 90% is already taken, it has been assumed that the opening balance of raw materials, work in progress and finished goods have already been brought to the desired level. Consequently, goods purchased during the period will be only for the production requirement and not for increasing the level of stock.
8. Problems
1. You are required to prepare a statement showing the working capital needed to finance a level of annual activity of 52,000 units of output. The following information are available :
Elements of cost | Rs. per unit | |
Raw Materials | 8 | |
Direct Labour | 2 | |
Overheads | 6 | |
Total cost | 16 | |
Profit | 4 | |
Selling price | 20 |
Raw materials are in stock, on an average for 4 weeks. Materials are in process, on an average, for 2 weeks. Finished goods are in stock, on an average, for 6 weeks. Credit allowed to customers is for 8 weeks. Credit allowed by suppliers of raw materials is for 4 weeks. Lag in payment of wages is 1½ weeks. It is necessary to hold cash in hand and at bank amounting to Rs. 75,000. It may be noted that production is carried on evenly during the year and wages and overheads accrue similarly.
[Answer : Working Capital requirement for 52,000 units (i.e., 1,000 unit per week) is Rs. 3,20,000.]
2. From the following information, prepare a statement showing estimated working capital requirement :
(i) Projected Annual sales 26,000 units.
(ii) Selling price per unit Rs. 60.
(iii) Analysis of selling price :
Material 40%; Labour 30%; Overheads 20%; Profit 10%.
(iv) Time lag (on average)
Raw materials in stock 3 weeks.
Production process 4 weeks.
Credit to debtors 5 weeks.
Credit by suppliers 3 weeks.
Lag in payment of wages and overheads 2 weeks.
Finished goods are in stock 2 weeks,
(v) Cash in hand is expected to be Rs. 32,000.
[Answer : Working Capital requirement is Rs. 2,69,000.]
3. From the following information presented by a manufacturing company, prepare a working capital requirement forecast for the coming year : Expected monthly sales of 32,000 units @ Rs. 10 per unit. The anticipated ratios of cost to selling prices are :
Raw Materials | 40% | |
Labour | 30% | |
Budgeted overheads | Rs. 16,000 per week | |
Overheads expenses include depreciation of Rs. 4,000 per week. Planned stock will include raw materials for Rs. 96,000 and 16,000 units of finished goods. | ||
Materials will stay in process for 2 weeks. | ||
Credit allowed to Debtors is 5 weeks. | ||
Credit allowed by Creditors is 1 month. | ||
Lag in payment of Overheads is 2 weeks. | ||
25% of sales may be assumed against cash and cash in hand is expected to be Rs. 25,000. | ||
Assume that production is carried on evenly throughout the year and wages and overhead accrue similarly. Assume also 4 weeks a month. | ||
[Answer : Working Capital requirement for a weekly sales of 8,000 units is Rs. 4,60,000. The overhead cost per unit is Rs. 1.50 (i.e.,(16,000–4,000)÷8,000) and cost of goods sold is 85% of selling price.] |
4. M/s. PQR and Co. have approached their bankers for their working capital requirement, who has agreed to sanction the same by retaining the margins as under :
Raw Materials | 20% |
Stock-in-process | 30% |
Finished goods | 25% |
Debtors | 10% |
From the following projections for next year you are required to work out :
(i) the working capital required by the company; and
(ii) the working capital limits likely to be approved by bankers.
Estimated for next year : | ||
Annual sales | Rs. 14,40,000 | |
Cost of production | 12,00,000 | |
Raw Materials purchases | 7,05,000 | |
Monthly expenditure | 25,000 | |
Anticipated Opening Stock of raw materials : | 1,40,000 | |
Anticipated Closing Stock of raw materials : | 1,25,000 | |
Inventory norms : | ||
Raw Material | 2 months | |
Work-in-progress | 15 days | |
Finished Goods | 1 month |
The firm enjoys a credit of 15 days on its purchases and allows one month credit on its supplier. On sales orders the company has received an advance of Rs. 15,000. State your assumptions, if any.
[Answer : Working capital Rs. 3,50,625, Loan to be approved at Rs. 3,32,750.]
______________
- Curran, W.S., Principles of Financial Management. McGraw-Hill Book Company, New York, First Edition, p. 161.
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