CH.

18 : WORKING CAPITAL : ESTIMATION AND CALCULATION 497

C H A P T E R

WORKING CAPITAL :
ESTIMATION AND CALCULATION 18
“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

: :
SYNOPSIS
u Estimation Procedure.
u Working Capital as a Percentage of Net Sales.
u Working Capital as a Percentage of Total
Assets.
u Working Capital Based on Operating Cycle.
n Need for Cash and Bank Balance.
n Need for Inventories.
n Need for Receivables.
n Provided by Creditors.
n Provided by Outstanding Wages and
Expenses.
u Estimation of Working Capital Requirement.
u Working Capital Estimation and Double Shift
Working.
u Graded Illustrations in Working Capital Esti-
mation.
T
he preceding chapter has thrown light on various
aspects of working capital planning, management and
control. The efficiency of the planning and manage-
ment 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 work-
ing 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

1. Curran, W.S., Principles of Financial Management. McGraw-Hill Book Company, New York, First Edition, p. 161.

497
498 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., cur-
rent 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
Net Sales ` 10,00,000 ` 12,00,000
Total Current Assets 2,00,000 2,52,000
Total Current Liabilities 50,000 60,000
Current Assets as a % of Sales 20% 21%
Current Liabilities as a %
of Sales 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 = ` 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 cur-
rent 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.
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 relation-
ship between (i) total current assets i.e., gross working
capital; or net working capital i.e., Current assets - Cur-
rent 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 esti-
mated 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 work-
ing 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 cur-
rent liabilities). So, the working capital estimation, being
a part of the investment decisions, should be made
Year 3
together with the capital budgeting decisions.
` 14,00,000
3,08,000 Both the above approaches to the estimation of working
70,000 capital requirement are relatively simple in approach but
22% difficult in calculation. The main shortcoming of these
approaches is that these require to establish the relation-
5%
ship 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 enu-
merated as follows :
 CH. 18 : WORKING CAPITAL : ESTIMATION AND CALCULATION
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 operat-
ing 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 esti-
mated 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 main-
tained, 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 vari-
ous 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 main-
tained 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 particu-
lar 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% com-
plete and some may be even 99% complete. These
499
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 unfin-
ished with respect to labour expenses and over-
head 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 car-
riage 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 receiv-
ables 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
500 PART VI : MANAGEMENT OF CURRENT ASSETS

working capital requirement in the above case, for different holding periods has been explained in the
receivables would be ` 60,000 only (i.e., ` 75,000 × previous chapter.
80%). (iii) Find out the rate per unit for each of these elements.
The total of working capital requirement for all the For example, the rates of raw materials, work in
above elements is also known as the gross working progress, finished goods are to be ascertained.
capital of the firm. At any particular point of time (iv) Find out the amount (funds) expected to be blocked
every firm requires this gross working capital as in each of these elements. For example, in raw mate-
there will be some units of raw materials in stores, rials, the funds blocked are :
some units in work-in-progress, some units as fin-
ished goods and there will be some debtors yet to be Av. holding period × No. of units required Per
collected. Period × Rate per unit.
(f) Creditors for the Purchases : Likewise a firm sells (v) Prepare the working capital estimation sheet and
goods and services on credit it may procure/pur- find out the working capital requirement.
chases raw materials and finished goods on credit
The calculation of net working capital may also be shown
basis. The payment for these purchases may be
as follows :
postponed for the period of credit allowed by suppli-
ers. So, the suppliers of the firm in fact provide Working Capital = Current Assets – Current Liabilities
working capital to the firm for the credit period. For = (Raw Material Stock + Work-in-
progress Stock + Finished Goods
example, a firm makes credit purchases of ` 60,000
Stock + Debtors + Cash Balance) –
per month and the credit allowed by the suppliers is (Creditors + Outstanding Wages +
two month, then the working capital supplied by the Outstanding Overheads),
creditors is ` 1,20,000 (i.e., ` 60,000×2 months). It where,
means that the firm would be getting the supplies Raw Material Stock = Cost (Average) of Materials in
without however, making the payment for two Stock.
months. The postponement of the payment to the Work-in-progress Stock = Cost of Materials + Wages + Over-
head of Work-in-progress.
creditors makes the firm to utilize this money else-
Finished Goods Stock = Cost of Materials + Wages + Over-
where or help the firm to sell on credit without head of Finished Goods.
blocking its own funds. Creditors for Material = Cost of Average Outstanding Credi-
(g) Creditors for Expenses and Wages : Usually, the tors.
expenses and wages are paid at the end of a month. Creditors for Wages = Average Wages Outstanding.
However, these wages and expenses accumulate in Creditors for Overhead = Average Overheads Outstanding.
the work-in-progress and finished goods on a regular Thus, Working Capital = Cost of Materials in Stores, in Work-
in-progress, in Finished Goods and
basis. The time lag in payment of wages and other in Debtors.
expenses also provide some working capital to the Less : Creditors for Materials
firm. It may be noted that these wages and expenses Plus : Wages in Work-in-progress,
are considered for the valuation of work-in-progress in Finished Goods and in Debtors.
and finished goods, but are paid usually at the end of Less : Creditors for Wages.
the month, providing a working capital to the firm Plus : Overheads in Work-in-
for that period. progress, in Finished Goods and in
Debtors.
The working capital estimation as per the method of Less : Creditors for Overheads.
operating cycle, is the most systematic and logical ap-
proach. In this case, the working capital estimation is The work-sheet for estimation of working capital re-
made on the basis of analysis of each and every compo- quirements under the operating cycle method may be
nent of the working capital individually. As already dis- presented as follows :
cussed, the working capital, required to sustain the level Estimation of Working Capital Requirements
of planned operations, is determined by calculating all
the individual components of current assets and current I. Current Assets : Amount Amount Amount
liabilities. There are different steps required for estima- Minimum Cash Balance ****
tion of working capital based on operating cycle. These Inventories :
Raw Materials ****
steps are :
Work-in-progress ****
(i) Identify the current assets and current liabilities to Finished Goods **** ****
be maintained. Estimation of each element of cur- Receivables :
rent assets and current liability is required. Debtors ****
(ii) Determine the average operating cycle (or holding Bills **** ****
period) for each of these elements. Calculation of Gross Working Capital (CA) **** ****
 CH. 18 : WORKING CAPITAL : ESTIMATION AND CALCULATION
II. Current Liabilities : Amount Amount Amount
Creditors for Purchases ****
Creditors for Wages ****
Creditors for Overheads ****
Total Current Liabilities (CL) **** ****
Excess of CA over CL ****
+ Safety Margin ****
Net Working Capital ****
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 esti-
mates 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.
DOUBLE SHIFT WORKING
In case, the firm is operating in double shift then a few
adjustments are required in the working capital estima-
tion. The double shift working has an effect on the
working capital requirement. The reason being that extra
working (production) would require additional raw ma-
terial 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 :
501
(i) That the requirement of raw material will in-
crease 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 incor-
porated 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 CL Effect on Working Capital
1. Raw Material in 1. Naturally, the Raw Materials
Store requirement of the firm would in-
crease. Unless given otherwise, it
should increase proportionately.
2. Raw Material in 2. 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 in 3. Total Labour cost will be in-
Work-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 Variable 4. Other Variable Expenses per
Expenses unit may remain same for second
shift, but total expense for the firm
will proportionately increase.
5. Fixed Expenses 5. Fixed Expenses may increase, if
new fixed cost element (e.g., New
Supervisor for second shift) is in-
curred.
6. Creditors for Goods 6. Creditors for goods will increase
in proportion to increase in raw
material purchases. However,
credit period may change.
7. Creditors for 7. Creditors for wages, overheads
Expenses. and other expenses may change in
proportion to change in the rel-
evant cost.
502 PART VI : MANAGEMENT OF CURRENT ASSETS

STUDENTS ACTIVITIES
u Every firm must estimate in advance as to how much
net working capital will be required for the smooth
operations of the business.
u 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.
u 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.
u At the work in progress stage, the three elements is
RM, wages and expenses are estimated separately.
POINTS TO REMEMBER
u Unless given otherwise, 100% RM is assumed to
introduced in the production process in the begin-
ning, but wages and expenses are assumed to accrue
evenly throughout the production process.
u The requirement for finished goods and work in
progress is taken at cash cost only and the amount of
depreciation is ignored.
u 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.
u While finding out the working capital requirement,
the firm should also include a safety margin to take
care of the contingencies.

GRADED ILLUSTRATIONS
Estimation of Working Capital Requirement
Illustration 18.1
The cost sheet of PQR Ltd. provides the following data : I. Current Assets : Amount Amount
Minimum Cash Balance ` 1,00.000
Cost per unit Inventories :
Raw material ` 50 Raw Materials (4,500 × ` 50) 2,25,000
Work-in-progress :
Direct Labour 20
Materials (4,500 × ` 50)/2 1,12,500
Overheads (including depreciation of ` 10) 40
Wages 50% of (4,500 × ` 20)/2 22,500
Total cost 110 Overheads 50% of (4,500 × ` 30)/2 33,750
Profits 20 Finished Goods (4,500 × ` 100) 4,50,000
Selling price 130 Debtors (4,500 × ` 100 × 75%) 3,37,500
Gross Working Capital 12,81,250 ` 12,81,250

Average raw material in stock is for one month. Average II. Current Liabilities :
material in work-in-progress is for half month. Credit Creditors for Materials (4,500 × ` 50) ` 2,25,000
allowed by suppliers: one month; credit allowed to debt- Creditors for Wages (4,500 × ` 20)/3 30,000
ors : one month. Average time lag in payment of wages: 10 Creditors for Overheads (4,500 × ` 30) 1,35,000
days; average time lag in payment of overheads 30 days. Total Current Liabilities 3,90,000 3,90,000

25% of the sales are on cash basis. Cash balance expected Net Working Capital ` 8,91,250

to be ` 1,00,000. Finished goods remains in the warehouse

Working Notes :
for one month.
1. The Overheads of ` 40 per unit include a depreciation
You are required to prepare a statement of the working
of ` 10 per unit, which is a non-cash item. This
capital needed to finance a level of the activity of 54,000
depreciation cost has been ignored for valuation of
units of output. Production is carried on evenly through-
work-in-progress, finished goods and debtors. The
out the year and wages and overheads accrue similarly.
overhead cost, therefore, has been taken only at ` 30
State your assumptions, if any, clearly.
per unit.
Solution :
2. In the valuation of work-in-progress, the raw materi-
As the annual level of activity is given at 54,000 units, it als have been taken at full requirements for 15 days;
means that the monthly turnover would be 54,000/12 = but the wages and overheads have been taken only at
4,500 units. The working capital requirement for this
monthly turnover can now be estimated as follows :
 CH. 18 : WORKING CAPITAL : ESTIMATION AND CALCULATION 503

50% on the assumption that on an average all units in Solution :

work-in-progress are 50% complete. Statement showing the Working
3. Since, the wages are paid with a time lag of 10 days, Capital requirement
the working capital provided by wages has been taken
Current Assets :
by dividing the monthly wages by 3 (assuming a
Stock of Raw materials (12,000 × 2 × ` 45) ` 10,80,000
month to consist of 30 days). Work-in-progress (12,000 × 1 × ` 105) × 50% 6,30,000
Finished goods (12,000 × 1 × ` 105) 12,60,000
Illustration 18.2 Debtors (12,000 × 2 × ` 105 × 80%) 20,16,000
Cash balances 1,00,000 50,86,000
The following information has been extracted from the
Current Liabilities :
records of a Company : Product cost sheet (per unit) :
Creditors of raw materials (12,000 × 1 × ` 45) 5,40,000
Raw Materials ` 45 Creditors for wages & overheads (12,000 ×
Direct Labour 20 60 ÷ 4) 1.5 2,70,000 8,10,000
Overheads 40 Net Working capital (C.A – C.L) 42,76,000

Total 105 Working Notes :

Profit
Selling price
- 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
15
1. Finished goods and Debtors have been taken at cost.
120
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.
Illustration 18.3
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 (exclu-
sive 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 assump-
tions, if any.

Solution : Statement of Net Working Capital Requirement

A. Current Assets :
(i) Raw materials in stock : (1,04,000 × 80 × 4)/52 ` 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
504 PART VI : MANAGEMENT OF CURRENT ASSETS

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 Statement of Working Capital Requirement
estimated on cash cost basis. Hence, investment in debtor
1. Current Assets : Amt. (`)
has been computed on cash cost.
Cash balance 20,000
Raw materials (1/6 of ` 36,00,000) 6,00,000
Illustration 18.4 Work-in-progress (Total cost ÷ 24 × 50%) 1,31,250
The management of Royal Industries has called for a Finished goods (Total cost ÷ 12) 5,25,000
statement showing the working capital to finance a level Debtors (75% × ` 63,00,000) × 1/6 7,87,500
of activity of 1,80,000 units of output for the year. The Total current assets 20,63,750
cost structure for the company’s product for the above 2. Current Liabilities :
mentioned activity level is detailed below : Creditors (` 36,00,000) × 1/12 3,00,000
Cost per unit Direct labour (` 9,00,000) × 1/12 75,000
Raw material ` 20 Overheads (` 18,00,000) × 1/24
Direct labour 5 (excluding dep.) 75,000
Overheads (including depreciation of ` 5 per unit) 15 Total current liabilities 4,50,000
40 Net working capital requirement 16,13,750
Profit 10
Selling price 50 Note : Depreciation is a non-cash item, therefore, it has
been excluded from total cost as well as working capital
Additional information : provided by overheads. Work-in-progress has been as-
(a) Minimum desired cash balance is ` 20,000. sumed to be 50% complete in respect of materials as well
(b) Raw materials are held in stock, on an average, for as labour and overheads expenses.
two months.
Illustration 18.5
(c) Work-in-progress (assume 50% completion stage for
Hi-tech Ltd. plans to sell 30,000 units next year. The
all components) will approximate to half-a-month’s
expected cost of goods sold is as follows :
production.
`(Per Unit)
(d) Finished goods remain in warehouse, on an average,
Raw material 100
for a month.
Manufacturing expenses 30
(e) Suppliers of materials extend a month’s credit and Selling, administration and financial expenses 20
debtors are provided two month’s credit; cash sales Selling price 200
are 25% of total sales.
The duration at various stages of the operating cycle is
(f) There is a time-lag in payment of wages of a month;
expected to be as follows :
and half-a-month in the case of overheads.
From the above facts, you are required to prepare a Raw material stage 2 months
statement showing working capital requirements. Work-in-progress stage 1 month
Finished stage 1/2 month
Solution : Debtors stage 1 month
Statement of Total Cost
Raw material (1,80,000 × ` 20) ` 36,00,000 Assuming the monthly sales level of 2,500 units, estimate
Direct labour (1,80,000 × ` 5) 9,00,000 the gross working capital requirement if the desired cash
Overheads (excluding depreciation) balance is 5% of the gross working capital requirement,
(1,80,000 × ` 10) 18,00,000 and work-in-progress is 25% complete with respect to
Total cost 63,00,000 manufacturing expenses.
 CH. 18 : WORKING CAPITAL : ESTIMATION AND CALCULATION 505

Solution : Solution :
Statement of Working Capital Requirement Statement of Working Capital Requirement

Current Assets : Amt.(`) Amt.(`) 1. Current Assets : Amount Amount

Stock of Raw Material (2,500 × 2 × 100) 5,00,000 Cash Balance ` 50,000
Work-in-progress : Stock of Raw Material (2,000 × 160 × 4) 12,80,000
Raw Materials (2,500 × 100) 2,50,000 Work-in-progress :
Manufacturing Expense 25% of Raw Materials (2,000 × 160 × 2) ` 6,40,000
(2,500 × 30) 18,750 2,68,750 Labour and Overheads (2,000 × 180 × 2)
× 50% 3,60,000 10,00,000
Finished Goods :
Finished Goods (2,000 × 340 × 4) 27,20,000
Raw Material (2,500 × 1/2 × 100) 1,25,000
Debtors (2,000 × 75% × 340 × 8) 40,80,000
Manufacturing Expenses
Total Current Assets 91,30,000
(2,500 × ½ × 30) 37,500 1,62,500
Debtors (2,500 × 150) 3,75,000 2. Current Liabilities :
13,06,250 Creditors (2,000 × ` 160 × 4) 12,80,000
Cash Balance (13,06,250 × 5/95) 68,750 Creditors for Wages (2,000 × ` 60 × 1½) 1,80,000
Working Capital Requirement 13,75,000 Creditors for Overheads (2,000 ×
` 120 × 4) 9,60,000
Note : Selling, administration and financial expenses Total Current Liabilities 24,20,000

have not been included in valuation of closing stock. Net Working Capital (CA – CL) 67,10,000

However, Debtors have been valued at full cost. Alterna-

tively, Debtors can also be valued at ` 30. Illustration 18.7
X Ltd. sells goods at a gross profit of 20%. It includes
Illustration 18.6
depreciation as part of cost of production. The following
Calculate the amount of working capital requirement for figures for the 12 months ending 31st Dec., 2018 are given
SRCC Ltd. from the following information : to enable you to ascertain the requirement of working
capital of the company on a cash cost basis.
` (Per Unit)
In your working, you are required to assume that:
Raw material 160
Direct labour 60 (i) a safety margin of 15% will be maintained;
Overheads 120 (ii) cash is to be held to the extent of 50% of current
Total cost 340 liabilities;
Profit 60
(iii) there will be no work-in-progress;
Selling price 400
(iv) tax is to be ignored.
Raw materials are held in stock on an average for one Stocks of raw materials and finished goods are kept at
month. Materials are in process on an average for half-a- one month’s requirements. All working notes are to form
month. Finished goods are in stock on an average for one part of your answer.
month.
Sales at 2 months credit ` 27,00,000
Credit allowed by suppliers is one month and credit Materials consumed (suppliers credit is
allowed to debtors is two months. Time lag in payment of for 2 months) 6,75,000
wages is 1½ weeks. Time lag in payment of overhead Total wages (paid at the beginning of
expenses is one month. One fourth of the sales are made the next month) 5,40,000
on cash basis. Manufacturing expenses outstanding at the
end of the year 60,000
Cash in hand and at the bank is expected to be ` 50,000 :
(These expenses are paid one month in
and expected level of production amounts to 1,04,000
arrears)
units for a year of 52 weeks.
Total administrative expenses (paid as above) 1,80,000
You may assume that production is carried on evenly Sales promotion expenses paid quarterly
throughout the year and a time period of four weeks is and in advance 90,000
equivalent to a month.
506 PART VI : MANAGEMENT OF CURRENT ASSETS

Solution : Cost of goods sold has been derived as follows :

Materials used 8,40,000
Calculation of Manufacturing Cost-(Cash Cost only)
Wages and Manufacturing expenses 6,25,000
Materials Consumed ` 6,75,000 Depreciation 2,35,000 17,00,000
Wages 5,40,000 -Stock of finished goods (10% of total
Cash manufacturing expenses (` 60,000 × 12) 7,20,000 production) 1,70,000
(A) Cash manufacturing cost 19,35,000 15,30,000
(B) Cost of sales (cash cost only)
The figures given above relate only to the goods that have
Cash manufacturing cost (as per ‘A’ above) 19,35,000
been finished and not to W.I.P goods which is equal to 15%
Administrative expenses 1,80,000
Sales promotion expenses 90,000
of the year’s production (in terms of physical units) on an
average, requiring full materials but only 40% of the other
22,05,000
expenses. The company believes in keeping 2 months
(C) Current liabilities consumption of material in stock.
Creditors for goods (1/6 of materials consumed) 1,12,500
Outstanding wages (1 month) (` 5,40,000/12) 45,000 All expenses are paid one month in arrears. Suppliers of
Cash manufacturing cost (outstanding one month) 60,000 material extend 1½ months credit. Sales are 20% cash, rest
Administrative expenses (outstanding one month) 15,000 are at 2 months credit. You can make such other assump-
2,32,500 tions as you deem necessary for estimating working
(D) Current assets capital requirement.
Debtors (at cash cost of sales) (` 22,05,000/12) × 2 3,67,500 Solution :
Stock of raw materials (` 6,75,000/12) 56,250
Finished stock (1/12 of ` 19,35,000) 1,61,250 Statement of Working Capital Requirement
Cash in hand - 50% of current liabilities 1,16,250
1. Current Assets
Advance payment of expenses (sales promotion) 22,500
Stock of Raw Materials (2/12 of 8,40,000) ` 1,40,000
Total Current assets 7,23,750
Work-in-progress :
- Current liabilities 2,32,500
Raw materials (15/100 of 8,40,000) ` 1,26,000
Excess of current assets over current liabilities 4,91,250 Wages and manufacturing
+ Safety margin 15% 73,687 (6,25,000 × 40% × 15%) 37,000 1,63,500
Working capital on cash cost basis 5,64,937 Stock finished goods :
[10% of (8,40,000 + 6,25,000)] 1,46,500
It may be noted that Gross Profit ratio is given at 20%. So, Debtors (2 months) :
the cost of production (inclusive of depreciation) is 80%. Cost of goods sold 15,30,000
-Depreciation (2,35,000–23,500) or, 90%
For Sales of ` 27,00,000, the total cost of goods sold comes
of (8,40,000 + 6,25,000) 2,11,500
to ` 21,60,000 (i.e. 80% of 27,00,000). But the cash manu- 13,18,500
facturing cost is only ` 19,35,000. Therefore, depreciation Adm. Expenses 1,40,000
would have been ` 2,25,000 (i.e. ` 21,60,000 – ` 19,35,000). Selling Expenses 1,30,000
Total Cost 15,88,500
Illustration 18.8 -Cash sales @ 20% 3,17,700
12,70,800
A company has applied a short-term loan to a commercial Debtors (2/12 of 12,70,800) 2,11,800
bank for financing its working capital requirement. You 6,61,800
are asked by the bank to prepare an estimate of the
2. Current Liabilities :
requirement of the working capital for that company.
Creditors (8,40,000/12 × 1½) ` 1,05,000
Add 10% to your estimated figure to cover unforeseen O/S Wages and Manufacturing exp.
contingencies. The information about the projected Profit (1/12 of 6,25,000) 52,083
and Loss A/c of the company is as under : O/S Administrative expenses
(1/12 of 1,40,000) 11,667
Sales ` 21,00,000 Selling expenses (1/12 of 1,30,000) 10,833 1,79,583
Cost of goods sold 15,30,000 Excess of current assets over current
Gross Profit 5,70,000 liabilities 4,82,217
Administrative expenses ` 1,40,000 + 10% for contingencies 48,222
Selling expenses 1,30,000 2,70,000 Working capital requirement 5,30,439

Profit before Tax 3,00,000

Provision for Tax 1,00,000 Illustration 18.9
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
 CH. 18 : WORKING CAPITAL : ESTIMATION AND CALCULATION 507

capital forecast for the next year. After carefully screen- Illustration 18.10
ing all the documents, he collected the following informa-
tion : Prepare a working capital forecast from the following
information :
Production during the previous year was 15,00,000 units.
Production during the previous year was 10,00,000 units.
The same level of activity is intended to be maintenance
The same level of activity is intended to be maintained
during the current year. The expected ratios of cost to
during the current year. The expected ratios of cost to
selling price are :
selling price are :
Raw materials 40%; Raw Materials 40%
Direct wages 20% Direct Wages 20%
Overheads 20% Overheads 20%
The raw materials ordinarily remain in stores for 3 months The raw materials ordinarily remain in stores for 3 months
before production. Every unit of production remains in before production. Every unit of production remains in
the process for 2 months and is assumed to be consisting the process for 2 months and is assumed to be consisting
of 100% raw material, wages and overheads. Finished of 100% raw material, wages and overheads. Finished
goods remain in warehouse for 3 months. Credit allowed goods remain in the warehouse for 3 months. Credit
by the creditors is 4 months from the date of the delivery allowed by creditors is 4 months from the date of the
of raw material and credit given to debtors is 3 months delivery of raw material and credit given to debtors is 3
from the date of dispatch. months from the date of dispatch.
The estimated balance of cash to be held : ` 2,00,000 Lag The estimated balance of cash to be held ` 2,00,000
in payment of Wages 1/2 month. Lag in payment of Lag in payment of wages 1/2 month
Expenses 1/2 month. Selling price is ` 10 per unit. Both Lag in payment of expenses 1/2 month
production and sales are in a regular cycle. You are
Selling price is ` 8 per unit. You are required to make a
required to make a provision of 10% for contingency
provision of 10% for contingency (except cash). Relevant
(except cash). Relevant assumptions may be made.
assumptions may be made.
Solution :
Solution :
Statement of Working Capital Requirement
Total Sales = 10,00,000 × 8 = ` 80,00,000
Current Assets Statement of Working Capital Requirement
Debtors (1,50,00,000 × 80% × 3/12) ` 30,00,000
A. Current Assets :
Finished goods (1,50,00,000 × 80% × 3/12) 30,00,000
Debtors (80,00,000 × 80% × 3/12) ` 16,00,000
Work in progress (1,50,00,000 × 80% × 2/12) 20,00,000 Finished Goods (80,00,000 × 80% × 3/12) 16,00,000
Raw Materials (1,50,00,000 × 40% × 3/12) 15,00,000 Work-in-progress (80,00,000 × 80% × 2/12) 10,66,667
Total Current Assets (A) 95,00,000 Raw Materials (80,00,000 × 40% × 3/12) 8,00,000
Total current assets 50,66,667 ` 50,66,667
Current Liabilities
B. Current Liabilities :
Creditors (1,50,00,000 × 40% × 4/12) ` 20,00,000 Creditors (80,00,000 × 40% × 4/12) 10,66,667
Wages (1,50,00,000 × 20% × 1/24) 1,25,000 Wages (80,00,000 × 20% × 1/24) 66,667
Expenses (1,50,000 × 20% × 1/24) 1,25,000 Overheads (80,00,000 × 20% × 1/24) 66,666 12,00,000
Excess of CA over CL 38,66,667
Total Current Liabilities (B) 22,50,000
+ 10% contingency 3,86,667
Excess of Current Assets over Current 42,53,334
Liabilities (A – B) ` 72,50,000 Cash 2,00,000
Add : Provision of 10% contingency 7,25,000 Working Capital Requirement 44,53,334
79,75,000
+ Cash required 2,00,000
Illustration 18.11
81,75,000
On 1st January, 2023, the Board of Directors of Dowell
Working Notes : Co. Ltd. wishes to know the amount of working capital
that will be required to meet the program of activity they
Total sales = 15,00,000 × ` 10 = ` 1,50,00,000
have planned for the year. The following informations
Assumptions : are available :
(i) All sales are made on credit basis. (i) Issued and paid-up capital ` 2,00,000.
(ii) The working capital blocked in debtors, finished (ii) 5% Debentures (secured on assets) ` 50,000.
goods and work-in-progress is taken at cost i.e., 80% (iii) Fixed assets valued at ` 1,25,000 on 31-12-2023.
of selling price.
508 PART VI : MANAGEMENT OF CURRENT ASSETS

(iv) Production during the previous year was 60,000 Projected Profit and Loss Account for the year ending
units. It is planned that the level of activity should December 2023
be maintained during the present year.
Sales (60,000 × 5) ` 3,00,000
(v) The ratios of cost to selling price are-raw materials –Raw material @ 60% ` 1,80,000
60%, direct wages 10%, and overheads 20%. –Direct Wages @ 10% 30,000
(vi) Raw materials are expected to remain in stores for –Overheads @ 20% 60,000 2,70,000
an average of two months before these are issued Gross Profit 30,000
for production. –Debenture Interest @ 5% on 50,000 2,500
(vii) Each unit of production is expected to be in process Net Profit 27,500
for one month.
Projected Balance Sheet as on Dec. 31, 2023
(viii) Finished goods will stay in warehouse for approxi-
mately three months. Liabilities Amt. (`) Assets Amt. (`)

(ix) Creditors allow credit for 2 months from the date of Share capital 2,00,000 Fixed assets 1,25,000
Profit and Loss A/c (Bal. Fig.) 8,750 Raw materials 30,000
delivery of raw materials. Profit for the year 2005 27,500 Finished goods 67,500
(x) Credit allowed to debtors is 3 months from the date 5% Debentures 50,000 Work-in-progress 18,750
of dispatch. Creditors 30,000 Debtors 75,000
3,16,250 3,16,250
(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 Illustration 18.12
Balance Sheet at the end of the year. Grow More Ltd. is presently operating at 60% level, pro-
Solution : ducing 36,000 units per annum. In view of favourable
market conditions, it has been decided that from 1st
Statement of Working Capital Requirement
January 2023, the Company would operate at 90% capac-
A. Current Assets Amount ity The following informations are available :
Raw Materials (1,80,000/6) ` 30,000 (i) Existing cost-price structure per unit is given
Work in progress (1 month) 18,750 below :
Finished goods (3 months) 67,500
Debtors (3 months) (2,70,000/4) 67,500
Raw material ` 4.00
Total Current Assets 1,83,750
Wages 2.00
Overheads (Variable) 2.00
B. Current Liabilities :
Overheads (Fixed) 1.00
Creditors (2 months consumption of RM) 30,000
Profits 1.00
Net working capital (CA - CL) 1,53,750
(ii) It is expected that the cost of raw material, wages
Working Notes : rate, expenses and sales per unit will remain un-
changed in 2023.
1. Computation of Cost and Sales for 60,000 units :
Sales @ ` 5 per unit ` 3,00,000 (iii) Raw materials remain in stores for 2 months before
Cost of production : these are issued to production. These units remain in
Raw material @ ` 3 per unit 1,80,000 production process for 1 month.
Direct Wages @ ` 0.50 per unit 30,000 (iv) Finished goods remain in godown for 2 months.
Overheads @ ` 1.00 60,000
(v) Credit allowed to debtors is 2 months. Credit allowed
Total Cost of Sales 2,70,000
by creditors is 3 months.

2. Calculation of work in progress (1 month production) : (vi) Lag in wages and overhead payments is 1 month. It
Raw material (` 1,80,000/12) ` 15,000 may be assumed that wages and overhead accrue
Direct Wages (` 30,000/12) × 50% 1,250 evenly throughout the production cycle.
Overheads (` 60,000/12) × 50% 2,500 You are required to :
18,750 (a) Prepare profit statement at 90% capacity level; and
The direct wages and overheads are assumed to have (b) Calculate the working requirements on an estimated
accrued evenly through out the month. So, only 1/2 basis to sustain the increased production level.
month wages and overheads are included work in Assumptions made if any, should be clearly indi-
progress. cated.
 CH. 18 : WORKING CAPITAL : ESTIMATION AND CALCULATION 509

Solution : finished goods have already been brought to the desired

Statement of Profitability at 90% Capacity level. Consequently, goods purchased during the period
will be only for the production requirement and not for
Units (at 90% capacity) 54,000 increasing the level of stock.
Sales (54,000 × ` 10) (A) ` 5,40,000
Cost : Illustration 18.13
Raw material (54,000 × ` 4) 2,16,000
Galfam Ltd. is presently operating on single shift basis
Wages (54,000 × ` 2) 1,08,000
and has the following cost structure (per unit) :
Variable overheads (54,000 × ` 2) 1,08,000
Fixed overheads (` 1 × 36,000) 36,000 Selling Price ` 36 Raw Material ` 12
Total cost (B) 4,68,000 Wages ` 10
Net profit (A-B) 72,000 Overheads ` 10
` 32
Statement of Working Capital Requirement
For the year ending March 31, 2023, the sales amounted
A. Current Assets to ` 8,64,000 and the current asset position on that day
Stock of raw materials (2 months × 4,500 × ` 4) ` 36,000 was as follows :
Work-in-progress :
Materials (1 month × 4,500 × ` 4) ` 18,000 Raw Material ` 72,000
Wages (1/2 month) 4,500 Finished Goods 1,44,000
Overheads (1/2 month) 6,000 28,500 Work in process (Prime Cost) (100%) 44,000
Finished goods (2 month) 78,000
Debtors 2,16,000
Debtors [2 months × (4,68,000/12)] 78,000
Total Current Assets 2,20,500 At present the company receives a credit of 2 months
from the supplier of raw materials and wages & expenses
B. Current Liabilities
are payable with a time log of half a month.
Sundry creditors (3 months) 54,000
Outstanding wages (1 month) 9,000 In order to meet the extra demand, the company is
Outstanding overhead (1 month) 12,000 preparing to work in double shift. The increased produc-
Total Current liabilities 75,000 tion will enable the firm to get a 10% discount from the
Working capital requirement (CA – CL) 1,45,500 supplier of raw materials. There will not be any change in
fixed cost, credit policy, etc., but the work in progress will
Working Note :
increase proportionately.
Overheads and Wages - The work in progress period is Ascertain the effect on requirement for working capital
one month. So, the wages and overheads included in if the proposal of double shift materializes.
work-in-progress, are on an average, for half month or 1/
Solution :
24 of a year.
In order to calculate the working capital requirement for
` 1,08,000
Wages = = ` 4,500 double shift operations, the existing parameters should
24 be ascertained as follows :
` 1,08,000 + 36,000 Present Position: Sales (` 8,64,000 ÷ 36) = 24,000 Units or
Overhead = = ` 6,000 2,000 units per month
24
The valuation of finished goods can also be arrived at as Debtors : (2,16,000 ÷ 8,64,000) × 12 = 3 months Outstand-
follows : ing.
Number of units = 4,500 × 2 = 9,000 Raw Material : (72,000 ÷ 12) = 6,000 Units or 3 months
Variable cost = ` 8 per unit requirement.
Fixed cost (` 36,000/12) × 2 = ` 6,000 Work in Process : (44,000 ÷ 22) = 2,000 Units or 1 month.
Total cost of finished goods (9,000 × 8) + 6,000 = ` 78,000
Finished Goods : (1,44,000 ÷ 32) = 4,500 units or 2.25
As the decision to increase the operating capacity from months requirement.
60% to 90% is already taken, it has been assumed that the
New Cost of Raw Material : ` 12–10% = ` 10.80
opening balance of raw materials, work in progress and

Working Capital Requirement

Single Shift (Present Position) Double Shift (Proposed Position)

Current Assets : Amount Current Assets : Amount
Raw Material (Given) ` 72,000 Raw Material (4,000 × 3 × 10.80) ` 1,29,600
Work in process (Given)(2,000 × 22) 44,000 Work in process (4,000 × 20.80) 83,200
510 PART VI : MANAGEMENT OF CURRENT ASSETS

Single Shift (Present Position) Double Shift (Proposed Position)

Current Assets : Amount Current Assets : Amount
Finished Goods (Given) 1,44,000 Finished Goods (4,000 × 2.25 × 30.80) 2,77,200
Debtors at cost (2,000 × 3 × 32) 1,92,000 Debtors at cost (4,000 × 3 × 30.80) 3,69,600
Total Current Assets : 4,52,000 Total Current Assets : 8,59,600
Less : Current Liabilities : Less : Current Liabilities :
Creditors : (2,000 × 12 × 2) 48,000 Creditors (4,000 × 10.80 × 2) 86,400
Wages & Expenses (2,000 × 20 × 1/2) 20,000 Wages & Expenses (4,000 × 20 × 1/2) 40,000
Working Capital Requirement 3,84,000 Working Capital Requirement 7,33,200

So, the Working Capital requirement will increase by (vi) Average time lag for payment of wages is 1/2 month
(` 7,33,200 – 3,84,000) = ` 3,49,200 due to change from and of overheads is 1 month.
single shift to double shift operations. (vii) The credit period extended by various suppliers
are :
Illustration 18.14
Gypsum - 2 months
Strong Cement Company Ltd. has an installed capacity of Coal -1 month
producing 1.25 lakh tonnes of cement per annum; its Packing material - 1/2 month
present capacity utilisation is 80%. The major raw mate-
(viii) Minimum desired cash balance is ` 25,00,000. You
rial of manufacturing cement is limestone which is ob-
may state your assumptions, if any.
tained on cash basis from a company located near the
plant. The company supplies cement in 200 kgs. drum. Solution :
From the information given below, determine the net Statement showing Requirement of Net Working
working capital (NWC) requirement of the company for Capital
the current year. Cost structure per drum of cement Current Assets :
(estimated) is as under :
Minimum desired cash balance ` 25,00,000
Gypsum ` 25 Raw Materials :
Limestone 15 Gypsum : (5,00,000 drums × ` 25 × 3/12) 31,25,000
Coal 30 Limestone (5,00,000 drums × ` 15 × 1/12) 6,25,000
Packing material 10 Coal (5,00,000 drums × ` 30 × 2.5/12) 31,25,000
Direct labour 50 Packing Material (5,00,000 drums × ` 10 ×
Factory overheads (including depreciation of ` 10) 30 1.5/12) 6,25,000
Administrative overheads 20 Work-in-progress : (Working note) 21,87,500
Selling overheads 25 Finished goods (5,00,000 drums × ` 170 ×
Total cost 205 1/12) 70,83,333
Profit margin 45 Debtors (5,00,000 drums × ` 220 × 3/12) 2,75,00,000
Selling price 250 Total Current Assets (A) 4,67,70,833
Add : Sales tax (10% of selling price) 25 Current Liabilities :
Invoice price to consumer 275
Creditors :
Additional information : Gypsum (5,00,000 × ` 25 × 2/12) ` 20,83,333
(i) Desired holding period of raw material : Coal (5,00,000 × ` 30 × 1/12) 12,50,000
Packing Material (5,00,000 × ` 10 × 1/24) 2,08,333
Gypsum 3 months Wages (5,00,000 × ` 50 × 1/24) 10,41,667
Limestone 1 month Overheads (5,00,000 × ` 65 × 1/12) 27,08,333
Coal 2.5 months Sales Tax (5,00,000 × ` 25 × 1.5/12) 15,62,500
Packing material 1.5 months Total Current Liabilities (B) 88,54,166
(ii) The product is in process for a period of 1/2 month Net Working Capital [(A) - (B)] 3,79,16,667
(Assume full units of gypsum, limestone and coal Working Notes :
are required in the beginning; other conversion (i) Total drums manufactured = 1,25,00,000 × 80% ÷ 200 kg.
costs are to be taken at 50%).
= 5,00,000 drums
(iii) Finished goods are in stock for a period of 1 month (ii) Cost of work-in-progress :
before they are sold. Materials (25 + 15 + 30) × 5,00,000 × 1/24 ` 14,58,333
(iv) Debtors are extended credit for a period of 3 months. Labour & Overheads (70 × 5,00,000 × 1/24
(v) Average time lag in payment of sales tax is 1/2 × 50%) 7,29,167
month. 21,87,500
 CH. 18 : WORKING CAPITAL : ESTIMATION AND CALCULATION 511

Packing Material, Depreciation, Administrative Overheads 1. Average credit period to customers 100 days
and Selling Overheads have been ignored for working 2. Average credit period from suppliers 70 days
progress.
3. Raw materials holding period 125 days
(iii) Cost of finished goods :
4. Work in progress cycle 30 days
Total cost ` 205
5. Finished goods holding period 90 days
Less : Depreciation 10
Less : Selling overheads 25 ` 170 You are required to find out the Net Operating Cycle. Also
make an estimate of working capital requirement for
(iv) Cash cost of debtors
goods as well as for other expenses. What is the ratio of
Total cost 205
working capital requirement to total cash operating ex-
Less : Depreciation 10 penses during the year (360 days a year).
Add : Sales Tax 25 220
Solution :
(v) Cash overheads
Total Annual Operating Expenses ` 850 lakhs
` (30 – 10 + 20 + 25) 65
Expenses for goods (60%) 510 lakhs
(vi) Administrative Overheads have been considered for Expenses for other elements (40%) 340 lakhs
valuation of Finished Goods. Gross Operating Cycle for goods (100 + 125 + 30 + 90) 345 days
Net Operating Cycle for goods (345 - 70) 275 days
Gross Operating Cycle for other expenses
Illustration 18.15
(RM – NIL, WIP – 30 × 50% = 15 days, FG - 90 days,
Debtors – 100 days) 205 days
XYZ Ltd. has a plant to manufacture computer printers.
Net Operating cycle for other expenses 205 days
Total cash operating expenses for the last year were ` 850
Working Capital Requirement for goods (510 ÷ 360) × 275 389.58 lakhs
lakhs. These expenses include the cash expenses (40%) as
Working Capital Requirement for others (340 ÷ 360) × 205 193.61 lakhs
well as those for goods (60%). Average operating cycle
Total Working Capital Requirement 583.19 lakhs
period for different elements are as follows :
Working Capital to Total Operating Expenses (583.19 ÷ 850) .686
or WC Turnover (to Total Operating Expenses) (850 ÷ 583.19) 1.46

1. Explain the factors considered while determining the
need for working capital.
2. Discuss the method of estimation of working capital
requirements based on sales.
3. How the value of work-in-progress can be estimated
? What are the relevant factors?
ASSIGNMENTS
4. Differentiate the working capital requirement based
on total cost basis and cash cost basis.
5. “Depreciation should be ignored while determining
the working capital need for a firm.” Why?

P18.1 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 ` per unit
Raw materials
Direct labour
Overheads
Total cost
Profit
Selling price
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 aver-
age, for 6 weeks. Credit allowed to customers is
for 8 weeks. Credit allowed by suppliers of raw
PROBLEMS
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 ` 75,000. It may be
noted that production is carried on evenly during
the year and wages and overheads accrue simi-
larly.
8
2 [Answer : Working Capital requirement for 52,000
6 units (i.e., 1,000 unit per week) is ` 3,20,000.]
16 P18.2 From the following information, prepare a state-
4 ment showing estimated working capital require-
ment :
20
(i) Projected Annual sales 26,000 units.
(ii) Selling price per unit ` 60.
(iii) Analysis of selling price :
Material 40%; Labour 30%; Overheads 20%;
Profit 10%.
512 PART VI : MANAGEMENT OF CURRENT ASSETS

(iv) Time lag (on average) (i) the working capital required by the com-
Raw materials in stock 3 weeks. pany; and
(ii) the working capital limits likely to be ap-
Production process 4 weeks.
proved by bankers.
Credit to debtors 5 weeks.
Estimated for next year :
Credit by suppliers 3 weeks. Annual sales ` 14,40,000
Lag in payment of wages and overheads 2 Cost of production 12,00,000
weeks. Raw materials purchases 7,05,000
Finished goods are in stock 2 weeks, Monthly expenditure 25,000
Anticipated opening stock of raw
(v) Cash in hand is expected to be ` 32,000.
materials : 1,40,000
[Answer : Working Capital requirement is Anticipated closing stock of raw
` 2,69,000.] materials : 1,25,000
Inventory norms :
P18.3 From the following information presented by a
manufacturing company, prepare a working capi- Raw material 2 months
tal requirement forecast for the coming year : Work-in-progress 15 days
Expected monthly sales of 32,000 units @ ` 10 per Finished goods 1 month
unit. The anticipated ratios of cost to selling prices The firm enjoys a credit of 15 days on its pur-
are : chases and allows one month credit on its sup-
Raw materials 40% plier. On sales orders the company has received an
Labour 30% advance of ` 15,000. State your assumptions, if
any.
Budgeted overheads ` 16,000 per week
Overheads expenses include depreciation of ` [Answer : Working capital ` 350,625, Loan to be
4,000 per week. Planned stock will include raw approved at ` 3,32,750.]
materials for ` 96,000 and 16,000 units of finished P18.5 ABC Ltd. has the undermentioned projected Profit
goods. and Loss Account—
Materials will stay in process for 2 weeks. Sales ` 42,00,000

Credit allowed to debtors is 5 weeks. Cost of goods sold 30,60,000

Credit allowed by creditors is 1 month. Gross profit 11,40,000

Administrative expenses ` 2,80,000
Lag in payment of overheads is 2 weeks.
Selling expenses 2,60,000 5,40,000
25% of sales may be assumed against cash and
Profit before tax 6,00,000
cash in hand is expected to be ` 25,000.
Provision for taxation 2,00,000
Assume that production is carried on evenly
throughout the year and wages and overhead Profit after tax 4,00,000
accrue similarly. Assume also 4 weeks a month. The cost of goods sold has
been arrived at as under—
[Answer : Working Capital requirement for a
weekly sales of 8,000 units is ` 4,60,000. The Materials used 16,80,000
overhead cost per unit is ` 1.50 (i.e., (16,000– Wages and manufacturing expenses 12,50,000
4,000)÷8,000) and cost of goods sold is 85% of Depreciation 4,70,000
selling price.] 34,00,000

P18.4 M/s. PQR and Co. have approached their bankers –Stock of finished goods 3,40,000
for their working capital requirement, who has (10% of goods produced not yet sold) 30,60,000
agreed to sanction the same by retaining the
The figures given above relate only to finished
margins as under :
goods not to work in progress. Goods equal to 15%
Raw Materials 20% of the year’s production (in terms physical units)
Stock-in-process 30% will be in process on the average requiring full
materials but only 40% of the other expenses. The
Finished goods 25%
company believes in keeping material equal to
Debtors 10%
two months consumption in stock. All expenses
From the following projections for next year you will be paid one month in arrear; Suppliers of
are required to work out : material will extend 1½ month’s credit; Sales will
 CH. 18 : WORKING CAPITAL : ESTIMATION AND CALCULATION 513

be 20% for cash and the rest two month’s credit. variable. In the first two years of operations,
The company wishes to keep ` 1,00,000 in cash. production and sales are expected to be as
Prepare an estimate of the requirement of (i) follows :
working capital on total cost basis and (ii) cash Year Production (No. of units) Sales (No. of units)
cost of working capital. 1 6,000 5,000
[Answer : The working capital on total cost basis 2 9,000 8,500
(i.e., including depreciation and profit on sales) is To assess the working capital requirements, the
` 12,03,285 and on cash basis (i.e., excluding de- following additional information is available :
preciation and profit on sale) is ` 9,91,685.]
Stock of materials 2.25 month’s average
P18.6 The board of directors of ABC Ltd. wishes to know consumption
the amount of working capital that will be re- Work in process Nil
quired to meet the program they have planned for Debtors 1 month’s average
sales
the year. From the following information prepare
Cash balance ` 10,000
a working capital requirement forecast and
Creditors for supply of materials : 1 month’s average pur-
projected Profit and Loss Account and Balance chases during the year
Sheet : Share Capital – ` 3,00,000; 8% Preference Creditors for expenses : 1 month’s average of
share capital – ` 40,000; 10% Debenture – ` 60,000; all expenses during the
Fixed assets – ` 2,65,000. year

Production during the previous year was 60,000 Prepare, for the two years.
units. It is planned that the same level of activity (i) A Projected statement of Profit and Loss
should be maintained in the current year. The (ignoring taxation); and
expected ratio of cost of selling price were : Raw
(ii) A Projected statement of working capital
material – 60%, Direct wage – 10%, Overheads –
requirements.
20%.
[Answer : Projected profit for year 1 and 2 are
Raw materials are expected to remain in store for
` 52,000 and ` 22,000 respectively. Working capi-
an average period of 2 months before being issued
tal requirement for two years are ` 1,52,916 and
to production department. Each unit of produc-
` 2,14,959 (the debtors have been considered at
tion is expected to be in progress for 1 month.
cost of sales i.e., including selling expenses).]
Time lag in wage payment is 1 month. Finished
goods will stay in warehouse awaiting despatch to P18.8 A Ltd. sells goods in the domestic market on a
customers for approximately 3 months. Credit gross profit of 25%. Its annual figures are as fol-
allowed by the creditors is 2 months from the date lows :
of delivery of raw material. Credit given to debt- (a) Sales at home, at 1 month credit ` 12,00,000.
ors 3 months from the date of despatch. Selling
(b) Export at 3 months credit, S.P. 10% below
price per unit is ` 5. Work in progress is valued at
the home price ` 5,40,000.
100% of material, labour and overhead expenses.
(c) Materials used, suppliers extend 2 months
[Answer : Working Capital requirement is
credit ` 4,50,000.
` 1,55,000. Net profit is ` 24,000 and total of
balance sheet is ` 4,60,000. The balancing figure if (d) Wages paid, half month in arrear ` 3,60,000.
any, may be assumed as unsecured loans.] (e) Manufacturing expenses, paid one month in
P18.7 ABC LIMITED is commencing a new project for arrear ` 5,40,000.
manufacture of a plastic component. The follow- (f) Depreciation on fixed assets ` 60,000.
ing cost information has been ascertained for
(g) Administrative expenses, paid one month in
annual production of 12,000 units which is the full
arrear ` 1,20,000.
capacity :
(h) Sales promotion expenses, payable quar-
Cost per unit (`)
terly in advance ` 60,000.
Materials 40
Direct labour and variable expenses 20 The company keeps one month stock of raw
Fixed manufacturing expenses 6 materials as well as finished product and believes
Depreciation 10 in keeping ` 1,00,000 available to it. Assuming 15%
Fixed administration expenses 4 safety margin, ascertain the working capital re-
` 80 quirement of the company.

The selling price per unit is expected to be ` 96 and [Answer: Working Capital requirement is
the selling expenses ` 5 per unit, 80% of which is ` 3,53,625.]