Financing of working capital

Sources of working capital

Permanent or fixed Temporary or variable

Shares
Debenture Commercial banks
Public deposit Trade creditors
Ploughing–back of profit Installment credit advance
Loans from financial institution Accounts receivable credit / factoring
Accrued expenses
Commercial paper
Working Capital
Requirement
Estimation of Working Capital Requirement
• The estimation of working capital is the determination of future cash
requirement of the firm so that the liquidity of financial resources may be
maintained.
• The following methods may be used for estimating working capital
requirement:
• Forecasting method
• Operating cycle method
• Projected balance sheet method
• Adjusted profit and loss method
• Cash forecasting method
1. Forecasting Method
• Under this method, various components of current assets and current liabilities are
determined. Following procedure is adopted in this case:
• Current Assets:
stock of raw material: the average period for which raw materials are kept in stock
is know as storage period. It is calculated as follow;
Estimated production in units × Estimated cost of raw material × Storage period(in
months or weeks) ÷ 12 Months or 52 weeks
Work in progress: work in progress includes cost of raw materials and part of wages
and factory expenses. This is also known as conversion period. It is calculated as follow:
Estimated production in units × Estimated cost of work in progress × conversion
period(in months or weeks) ÷ 12 Months or 52 weeks
Cont.…..
Finished Goods: this is known as storage period as finished goods remains
in godown for some days. It is calculated as follow:
Estimated production in units × cost of production in unit(excluding
depreciation) × Storage period(in months or weeks) ÷ 12 Months or 52 weeks
Sundry debtors: sundry debtors may be estimated on the basis of credit
sales and period of credit allowed. Such amount of debtors is determined either
at sales value or at cost. Administrative and selling and distribution overheads
are also considered. It is calculated as follow;
Estimated production in units × Cost of sale per unit× credit allowed to
customers (in months or weeks) ÷ 12 Months or 52 weeks
Cash and Bank Balance: the amount is estimated according to the
requirements of business for making day to day payments.
Current Liabilities
Sundry creditors: it is determined on the basis of credit purchase of raw
material and credit allowed by suppliers. It is calculated as follow:
Estimated production in units × raw material cost per unit × credit allowed by
suppliers (in months or weeks) ÷ 12 Months or 52 weeks
Out standing Expenses: this can be determined on the basis of time lag in
payment. Outstanding expenses are estimated as follow:
Estimated production in units × cost per unit× time lag in payment(in months or
weeks) ÷ 12 Months or 52 weeks
Statement of working capital requirement(for
a trading concern)
• Particulars
• Amount
• Current assets:
• Cash
• Debtors (for …… month sales)
• Stock (for …. Month sale)
• Advance payment if any
• Others
• Less: current liabilities
• Creditors ( for …. Month sale)
• Lag in payment of advances
• Working capital ( C. A – C. L)
• Add: provision for contingencies
• Net working capital
 Statement of working capital requirement ( for manufacturing
concern)
•Particulars
•amount
•Current assets:
•Stock of raw materials ( for …… months consumption)
•Work in progress ( for …….. Month)
• raw material
• direct labor
• overheads
•Stock of finished goods ( for …….. Month’s sale)
• raw material
• direct labor
• overheads
•Sundry debtors ( for ……. Month’s sale)
•Payment of advances
•Balance of cash
•Others
•Less: current liabilities
•Creditors( for ……… month)
•Lag in payment of expenses
•Others
•Working capital ( C.A,- C. L)
•Add: provision for contingencies
•Net working capital
Simple equation of working capital cycle
• WCC = R+W+F+D+B-C
• WCC = working capital cycle
• R = raw material
• W = work in progress
• F = finished stock
• B = cash at bank
• D = debtors collection period
• C = credit period available
 Operating Cycle method
• Material Storage Period = average stock of raw material ÷ average per
day consumption of raw material

• Average stock of raw material = (opening stock + closing stock)÷ 2

• Average per day consumption = raw material consumed during the year÷365
• Work in progress = average stock of WIP ÷ daily average production
cost
• Finished goods storage period = average stock of finished goods ÷
daily average of goods sold
Cont.….
• Debtors collection period = it is calculated on the basis of credit sales,
as follow: (average debtors + B/R) ÷ credit sales per day
Or
• [(Average debtors + B/R) ÷ net credit sales for the year ]×365
• Creditors payment period = it is calculated on the basis of credit
purchase. Creditors payment period = (average creditors + B/P) ÷
credit purchase per day
Or
[(average creditors + B/P) ÷ net credit purchase for the year] ×365
Cont. ……
• Number of operating cycle = 365÷ operating cycle period
• Working capital requirement = (total operating expenses ÷ number of
operating cycle) + expected cash and bank balance.
 Question
Particulars Amount

Total cost of sale 10,00,000

Average stock holding period 8 weeks
Average credit period allowed to customers 6 weeks
Average credit period allowed by supplier 5 weeks
Cash balance 60,000
Payment made in advance 15,000
Allow 8% for contingencies
Calculate the working capital requirement of the
trading concern from the following information
Question 2
Particulars Amount
Budget 5,20,000
Analysis of one rupee or sales Re.
Raw material .30
Direct labour .40
Overheads .20
Total costs
Profit .90
Sales .1
It is estimated that: 1.00
Raw material will be carried in stock for three weeks
Finished goods will be carried in stock for two weeks
Factory processing will take on an average of three
weeks( assumed 30%)
Supplier will give five weeks credit
Customers are allowed credit period of eight weeks.
Question 3
Particulars Amount per unit
Raw material 400
Direct labor 150
Overhead 300
Total cost 850
Additional information:
Selling price 1000 per unit
Output 26000 units
Raw material are in stock for an 4 weeks
WIP for 2 weeks (assume 50%
computation with material consumption)
Finished goods for 4 weeks
Credit period by supplier is 4 weeks
Credit period for debtors is 8 weeks
Cash in bank is 1,00,000
It is assumed that all sale is on credit.
Question 4
• Estimated cost per unit
• Raw material 70
• Direct labour 40
• Overheads 70
• Additional information:
• Selling price200
• Total output 1,04,000 units
• Raw material are in stock for an average of 4 weeks, WIP are in stock for average of 2 weeks
( assume 50% completion stage in respect of conversion cost, 100% in respect of raw material)
finished goods are in stock for 6 weeks, credit allowed by supplier is for average 6 weeks, credit
allowed to debtor is of 4 weeks and lag in payment of wages is for average 2 weeks, cash in bank is
expected to be 50,000. you are required to prepare the working capital requirement statement
assuming that all sale are on credit basis and 10 percent of computed figure will be for contingencies.
Question 5
• The management of company has called for a statement showing the working capital needs to
finance a level of activity of 30,000 units of output for the year. Cost structure for the above
mentioned activity level is detailed below:
• Cost per unit
• Raw material 20
• Direct labour 05
• Overheads 15
• Total cost 40
• Profit 10
• Selling price 50
• Raw material is held in stock for two months
• Work in progress ( 100% completed In regard to materials and 50% for labour and overheads)
will approximately to be half a month’s production.
• Finished goods remain in warehouse for a month
• Supplier of material give a month of credit
• Two month credit is allowed to debtors. Calculation may be made at selling price.
• A minimum cash balance of 25,000 is expected to be maintained.
•
 Question 6
• Raw material 80
• Direct wages 30
• Overheads 60
• Total cost 170
• Profit 30
• Selling price 200
• The following further information are available:
• Raw material is in stock on an average for one month.
• Material is in process on an average for half a month. Assume 50% completion stage in respect of
labour and overheads and 100% completion in respect to materials.
• Finished goods are in stock on an average for one month
• Credit allowed by the suppliers is one month
• Credit allowed to debtors is two months.
• Time lag in payment of wages is 1.5 weeks
• Time lag in payment of overhead expenses is one month
• One fourth of the output is sold against cash
• Cash in hand and at bank is expected to be 25,000
Question 7
• Following information is given you are required to calculate the estimate of working capital requirement:
• Expected level of production60,000 units
• Raw material in stock 2 month
• Processing period 1 month
• Finished goods in stock 3 month
• Credit allowed to customer 3 month
• Credit allowed by supplier 2 month
• Expected ratios of cost for selling price
• Raw material 60% 6
• Direct wages 10% 1
• Overheads 20% 2
• Selling price per unit is 10
• Expected margin on sale 10%
• Expected level of production 22000
• Raw material inventory 4 weeks
• Processing period 2 weeks
• Permanent material in process 200
• FINISHED goods in stock 6 weeks
• Credit allowed to customers 8 weeks
• Expected ratio of materials to sale price 72%
• Wages and overheads 22%
• Selling price per ton 3000