PART V : DIVIDEND
“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
Estimation Procedure.
Working Capital as a Percentage of Net Sales.
Working Capital as a Percentage of Total Assets.
Working Capital Based on Operating Cycle.
Need for Cash and Bank Balance.
Need for Inventories.
Need for Receivables.
Provided by Creditors.
Provided by Outstanding Wages and Expenses.
Estimation of Working Capital Requirement.
Working Capital Estimation and Double Shift Working.
Graded Illustrations in Working Capital Estimation.
The preceding chapter has thrown light on various aspects of working capital planning, management and control. 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 chapter looks into the steps and calculations required to estimate the working capital requirement for a firm.
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 :
1. 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
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PART VI : MANAGEMENT OF CURRENT ASSETS
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.
2. 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 50,00,000 next year. Thus, the current assets of the firm would be 10,00,000 (i.e., 20% of 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.
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= 14,00,000 + 10% thereof
= 15,40,000.
Net working capital as a % of sales = 16%.
= 15,40,000 × 16% = 2,46,400. The firm is expected to have gross working capital of 3,23,400 (i.e., 21% of 15,40,000) out of which financing by current liabilities is expected to be 77,000 (i.e., 5% of 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.
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.
3. 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 BalanceCreditors for Purchases
Inventory of Raw MaterialCreditors 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 21).
(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 10 per unit, then the working capital requirement is 2,700 (i.e., 270 × 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 semifinished 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-inprogress 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 1,50,000 per month and a credit of 15 days given to customers. The working capital locked up in receivables is 75,000 ( 1,50,000 × 1/2 month).
However, an important point is worth noting here. The calculation of 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
PART VI : MANAGEMENT OF CURRENT ASSETS
working capital requirement in the above case, for receivables would be 60,000 only (i.e., 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 60,000 per month and the credit allowed by the suppliers is two month, then the working capital supplied by the creditors is 1,20,000 (i.e., 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-inprogress Stock + Finished Goods Stock + Debtors + Cash Balance) –(Creditors + 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=Cost of Materials + Wages + Overhead of Finished Goods.
Creditors for Material=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 Workin-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-inprogress, 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 :
Estimation of Working Capital Requirements
Following points are also worth noting while estimating the working capital requirement :
1. 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.
2. 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.
In case, the firm is operating in double shift then a few adjustments are required in the working capital estimation. The double shift working has an effect on the working capital requirement. The reason being that extra working (production) would require additional raw material and would result in higher stock of finished goods. Sometimes, the firm may be required to pay a higher wage rate to the labour. Fixed costs of production may remain same or may increase. The calculation of working capital requirement for double shift should be made depending on the information. If sufficient information is not available, then some assumptions may be made as follows :
(i)That the requirement of raw material will increase proportionately. The storage period of raw material may remain same. Similarly, stock of finished goods will also increase.
(ii)The work on work-in-progress of the first shift will continue in the second shift and no extra funds would be blocked in the work in progress.
(iii)Fixed costs may remain same, and consequently, the fixed cost per unit will decrease as the total production increases.
(iv)The cost of raw materials and the selling price per unit of finished goods may decrease because of larger volumes. This change should be incorporated in the working capital estimation. The effects of different CA and CL on working capital requirement due to Double Shift Operations are given below :
Item of CA or CLEffect on Working Capital
1.Raw Material in1. Naturally, the Raw Materials Store requirement of the firm would increase. Unless given otherwise, it should increase proportionately.
2.Raw Material in2. There would be no increases Work-in-progress because the work-in-progress of first shift will continue in second shift, and so on.
3.Labour cost in3. Total Labour cost will be inWork-in-progress curred in both the shifts. So, labour expenses will increase. Rate per unit or Rate per hour may be same or different in two shifts.
4.Other Variable4. Other Variable Expenses per Expenses unit may remain same for second shift, but total expense for the firm will proportionately increase.
5.Fixed Expenses5. Fixed Expenses may increase, if new fixed cost element (e.g., New Supervisor for second shift) is incurred.
6.Creditors for Goods6. Creditors for goods will increase in proportion to increase in raw material purchases. However, credit period may change.
7.Creditors for7. Creditors for wages, overheads Expenses. and other expenses may change in proportion to change in the relevant cost.
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 deducted 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.
Estimation of Working Capital Requirement
The cost sheet of PQR Ltd. provides the following data :
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 1,00,000. Finished goods remains 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 :
II.Current
for Materials (4,500 × 50) 2,25,000
for Wages (4,500 × 20)/330,000
(4,500 × 30)1,35,000
Working Notes :
1.The Overheads of 40 per unit include a depreciation of 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 30 per unit.
2.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.
3.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).
The following information has been extracted from the records
-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 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
:
showing the Working Capital requirement
:
Finished goods (12,000 × 1 × 105) 12,60,000
Debtors (12,000 × 2 × 105 × 80%) 20,16,000
Cash balances
Current Liabilities :
1,00,00050,86,000
Creditors of raw materials (12,000 × 1 × 45)5,40,000
Creditors for wages & overheads (12,000 × 60 ÷ 4) 1.5 2,70,0008,10,000
Net Working capital (C.A – C.L) 42,76,000
Working Notes :
1.Finished goods and Debtors have been taken at cost.
2.Production per month has been taken at 12,000 units. For payment of wages and overheads, month is taken as consisting of 4 weeks.
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 170 includes raw materials 80, direct labour 30 and overheads (exclusive of depreciation) 60. Selling price is 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 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.
Assumptions : Net working capital requirement has been estimated on cash cost basis. Hence, investment in debtor has been computed on cash cost.
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 :
Statement of Working Capital Requirement
1.Current Assets :
Cash balance
Raw materials (1/6 of 36,00,000)
Additional information :
(a)Minimum desired cash balance is 20,000.
(b)Raw materials are held in stock, on an average, for two months.
(c)Work-in-progress (assume 50% completion stage for all components) 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 :
( )
Work-in-progress (Total cost ÷ 24 × 50%)1,31,250
Finished goods (Total cost ÷ 12) 5,25,000
Debtors (75% × 63,00,000) × 1/6 7,87,500 Total current assets 20,63,750
2.Current Liabilities :
Creditors ( 36,00,000) × 1/12 3,00,000
Direct labour ( 9,00,000) × 1/12 75,000
Overheads ( 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.
Hi-tech Ltd. plans to sell 30,000 units next year. The expected cost of goods sold is as follows :
The duration at various stages of the operating cycle is expected to be as follows :
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.
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 30.
Raw materials are held in stock on an average for one month. Materials are in process on an average for half-amonth. 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 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.
X Ltd. sells goods at a gross profit of 20%. It includes depreciation as part of cost of production. The following figures for the 12 months ending 31st Dec., 2018 are given to enable you to ascertain the requirement of working capital of the company on a cash cost basis.
In your working, you are required to assume that:
(i)a safety margin of 15% will be maintained;
(ii)cash is to be held to the extent of 50% of current liabilities;
(
iii)there will be no work-in-progress;
(iv)tax is to be ignored.
Stocks of raw materials and finished goods are kept at one month’s requirements. All working notes are to form part of your answer.
Sales at 2 months credit
Materials consumed (suppliers credit is for 2 months)
Total wages (paid at the beginning of the next month)
(These expenses are paid one month in arrears)
Total administrative expenses (paid as above)1,80,000
506
Solution :
(B)Cost
PART VI : MANAGEMENT OF CURRENT ASSETS
Cost of goods sold has been derived as follows :
Materials used
only)
(D)Current
It may be noted that Gross Profit ratio is given at 20%. So, the cost of production (inclusive of depreciation) is 80%. For Sales of 27,00,000, the total cost of goods sold comes to 21,60,000 (i.e. 80% of 27,00,000). But the cash manufacturing cost is only 19,35,000. Therefore, depreciation would have been 2,25,000 (i.e. 21,60,000 – 19,35,000).
A company has applied a short-term loan to a commercial bank for financing its working capital requirement. You are asked by the bank to prepare an estimate of the requirement of the working capital for that company. Add 10% to your estimated figure to cover unforeseen contingencies. The information about the projected Profit and Loss A/c of the company is as under :
8,40,000
Wages and Manufacturing expenses6,25,000
Depreciation
-Stock of finished goods (10% of total production)
2,35,00017,00,000
1,70,000
15,30,000
The figures given above relate only to the goods that have been finished and not to W.I.P goods which is equal to 15% of the year’s production (in terms of physical units) on an average, requiring full materials but only 40% of the other expenses. The company believes in keeping 2 months consumption of material in stock.
All expenses are paid one month in arrears. Suppliers of material extend 1½ months credit. Sales are 20% cash, rest are at 2 months credit. You can make such other assumptions as you deem necessary for estimating working capital requirement.
Solution :
Statement of Working Capital Requirement
1.Current Assets
Stock of Raw Materials (2/12 of 8,40,000) 1,40,000
Work-in-progress :
Raw materials (15/100 of 8,40,000) 1,26,000
Wages and manufacturing (6,25,000 × 40% × 15%)
2.Current Liabilities :
× 1½)
exp.
37,0001,63,500
Estallia Garment Co. Ltd. is a famous manufacturer and exporter of garments to the European countries. The finance manager of the company is preparing its working
capital forecast for the next year. After carefully screening all the documents, he collected the following information :
Production during the previous year was 15,00,000 units. The same level of activity is intended to be maintenance during the current year. The expected ratios of cost to selling price are :
Raw materials
Direct wages
Overheads
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 warehouse for 3 months. Credit allowed by the 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 : 2,00,000 Lag in payment of Wages 1/2 month. Lag in payment of Expenses 1/2 month. Selling price is 10 per unit. Both production and sales are in a regular cycle. You are required to make a provision of 10% for contingency (except cash). Relevant assumptions may be made.
Solution :
Statement of Working Capital Requirement
Working Notes :
Total sales = 15,00,000 × 10 = 1,50,00,000
Assumptions :
(i)All sales are made on credit basis.
(ii)The working capital blocked in debtors, finished goods and work-in-progress is taken at cost i.e., 80% of selling price.
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 Materials40%
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 2,00,000
Lag in payment of wages 1/2 month
Lag in payment of expenses 1/2 month
Selling price is 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 = 80,00,000
Statement of Working Capital Requirement
A.Current Assets :
(80,00,000 × 80% × 3/12)
On 1st January, 2023, the Board of Directors of Dowell Co. Ltd. wishes to know the amount of working capital that will be required to meet the program of activity they have planned for the year. The following informations are available :
(i)Issued and paid-up capital 2,00,000.
(ii)5% Debentures (secured on assets) 50,000.
(iii)Fixed assets valued at 1,25,000 on 31-12-2023.
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PART VI : MANAGEMENT OF CURRENT ASSETS
(iv)Production during the previous year was 60,000 units. It is planned that the level of activity should be maintained during the present year.
(v)The ratios of cost to selling price are-raw materials 60%, direct wages 10%, and overheads 20%.
(vi)Raw materials are expected to remain in stores for an average of two months before these are issued for production.
(vii)Each unit of production is expected to be in process for one month.
(viii)Finished goods will stay in warehouse for approximately three months.
(ix)Creditors allow credit for 2 months from the date of delivery of raw materials.
(x)Credit allowed to debtors is 3 months from the date of dispatch.
(xi)Selling price per unit is 5.
(xii)There is a regular production and sales cycle. Also prepare an estimated Profit and Loss Account and Balance Sheet at the end of the year.
Projected Profit and Loss Account for the year ending December 2023
Sales (60,000 × 5)
–Raw material @ 60% 1,80,000
–Direct Wages @ 10% 30,000
–Overheads @ 20% 60,0002,70,000
Projected Balance Sheet as on Dec. 31, 2023
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 2023, the Company would operate at 90% capacity The following informations are available :
(
)Existing cost-price structure per unit is given below :
The direct wages and overheads are assumed to have accrued evenly through out the month. So, only 1/2 month wages and overheads are included work in progress.
(ii)It is expected that the cost of raw material, wages rate, expenses and sales per unit will remain unchanged in 2023.
(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.
of Working Capital Requirement
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.
Galfam Ltd. is presently operating on single shift basis and has the following cost
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.
For the year ending March 31, 2023, the sales amounted to 8,64,000 and the current asset position on that day was as follows :
Raw Material
Work in process (Prime Cost) (100%) 44,000
2,16,000
At present the company receives a credit of 2 months from the supplier of raw materials and wages & expenses are payable with a time log of half a month.
In order to meet the extra demand, the company is preparing to work in double shift. The increased production will enable the firm to get a 10% discount from the supplier of raw materials. There will not be any change in fixed cost, credit policy, etc., but the work in progress will increase proportionately.
Ascertain the effect on requirement for working capital if the proposal of double shift materializes.
Solution :
In order to calculate the working capital requirement for double shift operations, the existing parameters should be ascertained as follows :
Present Position: Sales ( 8,64,000 ÷ 36) = 24,000 Units or 2,000 units per month
The valuation of finished goods can also be arrived at as follows :
Debtors : (2,16,000 ÷ 8,64,000) × 12 = 3 months Outstanding.
Raw Material : (72,000 ÷ 12) = 6,000 Units or 3 months requirement.
Work in Process : (44,000 ÷ 22) = 2,000 Units or 1 month.
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 : (1,44,000 ÷ 32) = 4,500 units or 2.25 months requirement.
New Cost of Raw Material : 12–10% = 10.80
