Estimation Procedure

Working Capital as a Percentage of Net Sales

Working Capital as a Percentage of Total Assets
Working Capital Based on Operating Cycle
Estimation of Working Capital Requirement
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.

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:

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.

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 years. 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 summarized in the Table below:
Elements of Working Capital and Relation with Time & Value Factors
Source Item Time Factor Value Factor

1. Raw
Storage Period Value of Raw Material stored for that period
Material

2. Work-in- Production Period Raw Materials consumed + Labour Cost incurred

Progress (Conversion Period) + Manufacturing expenses

Raw Materials Consumed + Labour Cost incurred

3. Finished Finished Goods
+ Manu- facturing expenses + Adminis- trative
Goods Storage Period
Cost

Raw Materials Consumed + Labour Cost Incurred

4. Debtors Credit Period Allowed + Manu- facturing expenses + Adminis- trative
Cost

Deferral Period
5. Creditors Value of Raw Materials Purchased in that period.
Allowed

6. Labour
Lag Period in Payment Labour expenses during the lag period
Cost

7. Overhead
Lag Period in Payment Overhead expenses during the lag period.
Expenses
Both these factors have been considered by operating cycle approach to working capital, and has
been discussed below.

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 asset 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,
= Cost (Average) of Materials in Stock.
Raw Material Stock

= Cost of Materials + Wages + Overhead of

Work-in-progress Stock
Work-in-progress.

= Cost of Materials + Wages + Overhead of

Finished Goods Stock Creditors for Material
Finished Goods.

Creditors for Materials = Cost of Average Outstanding Creditors.

Creditors for Wages = Average Wages Outstanding.

 Creditors for Overhead = Average Overheads Outstanding.

= 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
Thus, Working Capital 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

600,00,00
0
Working Capital for Cost of goods sold =  × 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

1,04,000 units per

Level of activity
annum

Raw Materials in stock average 4 weeks

Work in progress [Assume 100% stage of completion of materials and

average 2 weeks
50 per cent for labour and overheads]

Finished Goods in Stock average 4 weeks

Credit allowed by Suppliers average 4 weeks

Credit allowed to Debtors average 8 weeks

average 1 1/2
Lag in payment of Wages
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 Amount
 . (Rs. ) (Rs. )

Raw Materials (2000 × 4 × 100) 8,00,000

Work in Progress

Raw Material (2000 × 2 × 100) 4,00,000

(2000 × 2 × 40)
Wages 80,000
50%

(2000 × 2 × 80)
Overheads 1,60,000 6,40,000
50%

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

9,20,000
(CL)

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 :
Total Cost (Cash)
Requirement per day =
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.
Rs. 1,08,000
Wages =  = 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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