21/04/2020 Forecasting of Working Capital Requirement: 6 Steps

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Forecasting of Working Capital

Requirement: 6 Steps
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The following points highlight the six steps involved in forecasting of

working capital requirements.

Step # 1:

Collection of the following information affecting the working capital

requirements:

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(a) The expected production during the year. India’s Most Loved Rummy Site. Play Now !
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(b) The expected cost of raw materials, labour and overheads per unit of production.
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21/04/2020 Forecasting of Working Capital Requirement: 6 Steps

(c) The period during which raw materials will remain in store before it is issued to
production process.

(d) The length of processing or conversion time which the work-in-progress is to be

kept in the production process.

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(e) The period during which finished products will remain in warehouse before sale.

(f) The period of credit allowed to debtors for credit sales.

(g) The period of credit allowed by creditors for credit purchase of raw materials.

(h) The time-lag in payment of wages and overheads.

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(i) The inclusion of profit element in the debtors.

(j) The nature of production and overheads accruing throughout the year.

Step # 2:

Determine average estimated production (week, fortnight or month etc.)

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Step # 3:

Determine average expected cost (week, fortnight, month etc.) of each element of cost
viz. material, labour and overheads.

Step # 4:

Determine the net block period for each element of cost viz. material, labour and
overhead. For instance, raw material may be in store for 2 months, in processing 1
month, in finished goods condition 2 months, in the hands of debtors 4 months and is
usually paid for 1 month after credit purchase. So the net block period is (9 – 1) or 8
months i.e., the period during which fund for raw material will remain blocked.
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Step # 5:

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21/04/2020 Forecasting of Working Capital Requirement: 6 Steps

Multiply the net block period of each element of cost with their average periodical cost
separately. This will give working capital requirement for each element of cost. For
example, if the net block period of material is 8 months and monthly cost of raw
material is Rs. 10,000, then working capital to be maintained for raw material is (8 x
Rs. 10,000) or Rs. 80,000. In this way working capital requirement for wages and
overheads will have to be found out.

Step # 6:

Lastly, add the item-wise working capital requirement as found out in (5) to arrive as
total working capital requirement. Sometimes working capital requirements can be
determined from the viewpoint of trading concern and from the viewpoint of
manufacturing concern.

From the viewpoint of trading concern, the working capital forecast is

made in the following manner:

From the viewpoint of manufacturing concern, the working capital requirement

forecast is prepared in matrix form from which one is able to know the working capital
requirement for each item of current assets as well as for each element of cost.

A proforma of working capital requirement forecast is given below to clear

the idea of matrix form:
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21/04/2020 Forecasting of Working Capital Requirement: 6 Steps

Working Notes:

(i) When wages and overheads are not introduced at the beginning of the production
process i.e., wages and overheads are accrued evenly throughout the processing period,
it may be assumed that, they were completely introduced for half the process time. It is
not so in case of raw materials as the same are generally introduced at the beginning of
a process. So in case of wages and overheads, the time or period of work- in-progress
will be the half of the normal time required.

(ii) If any cash in hand is required for contingencies, the same is not shown in the
above statement. The amount of required cash in hand is to be added with the total of
the working capital requirement forecast as per the statement.

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(iii) Bills payable is a part of creditors. So it need not be considered separately.
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(iv) Depreciation is a non-cash cost item. The amount of depreciationRead

is to be
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from the total amount of overhead.

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21/04/2020 Forecasting of Working Capital Requirement: 6 Steps

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