Management of Working Capital Every business needs funds for two purposes-for its establishment and to carry Out its day-to-day operations. Long-term funds are required to create production facilities through purchase of fixed assets such as plant afd machinery, land, building, furniture, etc. Investments in these assets represent that part of firm’s capital which is blocked on a permanent or fixed basis and is called fixed capital. Funds are also needed for short-term purposes for the purchase of raw materials, payment of wages and other day-to-day expenses, etc. These funds are known as working capital. Working capital may be regarded as lifeblood of a business. Its effective provision can do much to ensure the success of a business, while its inefficient management can lead not only to loss of profits but also lead to the ultimate down fall of a concern. Hence, working capital management if carried out effectively, efficiently and consistently, will assure the health of an organisation. CONCEPT OF WORKING CAPITAL For the proper understanding of working capital, it is necessary to understand the various concepts of working capital. The main concepts of working capital are as follows Seg hens: ative Concept, 2 Qualitative Concept. L-Quantitative Concept : This is also known as ‘Gross Working Capital Concept’. The ‘maint followers of this concepts are Med, Mallot, Field, Baker, Bonneville and Mill etc. According to this concept working capital is the total of all the current assets. This view pl: more emphasis on the quantitative aspect of working capital rather than its qualitative, aspect. The en given in support of be view is ts ‘th ist i usiness operations, it does not make as al the current assets assist in the conduct of per Blois | whether they are financed by long-term funds or by current or “Working Capital means Current Assets.” ition of funds which increases the current capital, for they are one and the same.” definition that Bonneville has used the working capital e sense. We= CA aspect of working capital. This is also known as This concept is mainly followed by Lincon, Sayors ept the excess of the current assets over current current assets and current liabilities are g capital in the business. On the other hand, if is the amount of current assets, such a situation This situation does not generally exist in a 2 ion of crisis. This concept is known asFinancial Mana, BEM u ition of the business ang lity pos c it shows the liquid concept because cong Sect thy quattve coment eh the working capital as been financed through long 48 indicates the 7 Ling concept i8 financial of going Concern concept Whereag The gross working sunting concept of working capital. These two COMCEDKS of a capa is an acon ve, rather both have their own merits. The gross cq eta the met concept of working capital forthe following rasa workin velit Oe Poeved tothe wel 6 « nesting re the enterprise to provide correct amount of working capital at & ie aieaaadal is more interested in the total current assets with Which it has to operate than the sources from where it is made available, 3. The gross concept takes into consideration the fact that every increase in the funds of the enterprise would increase its working capital. 4, The gross concept of working capital is more useful in determining the rate y of return on investments in working capital. The net working capital concept, however, is also important for the following reasons, LM 1s a qualitative concept which indicates the firm’s ability to meet its ‘operating expenses and short-term liabilities. } Ut indicates the margin of protection available to the short-term creditors, 4e., the excess of current assets over current liabilities. 311 is an indicator of the financial soundness of an enterprise. w 4, It suggests the need for financing a part of the working capital requirements ‘out of permanent sources of funds. To conclude, it may be said that, both, gross and net, concepts of working capital ats important aspects of the working capital management. The net concept of working capital may be suitable only for proprictory form of Organisations such as sole-trader or partnership firms, But the gross concept is very suitable to the company form of organisation where there is a separation between owenership, management and However, it is important to note here that as per the general practice, net working. referred simply as working capital, In the words of Hoagland, “Working pital is dese that capital which is not fixed. But the more common use of consider it as the difference between the book value of the nt liabilities.” OR TYPES OF WORKING CAPITAL fied on the following two basis : ts: On the basis of concepts working capital cam be + Gross working capital is the amount of funds of current assets. net working capital is the difference bar Concept of net working capital enables is roe operational requirements. This is capital. a aeManagement of Working Capital 93 _ , ; 2..On the basis of Necessities : Working capital can be divided into two categories on the basi of necessities * oer manent (Fixed or Core) Working Capital : This refers to that minimum amount of investment in all current assets which is required at all times to carry out minimum level of business activities. In other words, it represents the current assets ~ required on a continuing basis over the entire year. For example, every firm has to maintain a minimum level of raw materials, work-in-process, finished goods and cash balance. This minimum level of current assets is called permanent or fixed working capital as this part of capital is permanently blocked in current assets. This amount varies from year to year, depending upon the growth of the company and the stage of the business cycle in which it operates. Permanent working capital is needed permanently for the business and, therefore, it should be financed out of long-term funds. r (b) Temporary (Seasonal or Variable) Working Capital : The amount of such working capital keeps on fluctuating from time to time on the basis of business activities. For example, extra inventory has to be maintained to support sales during peak sales period. Similarly, receivables also increase and must be financed during the period of high sales. On the other hand, investment in inventories, receivables, cs etc., will decrease in periods of depression. Hence, it is that part of total working capital which varies with variation in the volume of business operations. It rises during busy or brisk seasons and goes down during slack season. It can therefore, be called seasonal working capital also. Suppliers of temporary working capital can expect its return during off season + when it is not required by the firm. Hence, temporary working capital is generally financed from short-term sources of finance such as bank credit. | COMPONENTS OF WORKING CAPITAL There are two components of working capital, viz., Current Assets ai nd Current Lial ets. Current assets are those assets which can be converted into cash in the normal course of business within a short period:say a maximum of one year. They are also called floating or circulating assets because they can not be put to constant use. They are meant for resale or produced for the purpose of sale ie., cc them into cash. In brief, the list of current assets comprises of: sh in hand and bank balances. 'on Fina cial Ma Bey 2. Current Liabilities : Current liabilities are those liabilities which are inte to be paid in the ordinary course of business within a short period of normally! accounting year out of the current assets or the income of the business. Example, current liabilities are : o itors or Accounts Payable. Accrued or Outstanding Expenses. “4-Short-term loans, advances and deposits. 5. Dividends Payable. 6. Bank Overdraft. 7. Provision for taxation, if it does not amount to appropriation of Profits, In order to ascertain the real position of working capital, certain adjustmeng, which are abnormal in riature, are to be adjusted against each component of current assets and current liabilities. At the same time, it is also to be looked into whether oF not, the current assets or current liabilities are window-dressed. The Need or Objects of Working Capital ~The need for working capital cannot be over em some amount of working capital. T! gap between production and realis; f_cash from sales. There is an operating cycle involved in the sales and realisation of cash. There are time gaps in of raw materials and production ; pr ion s, workin, needed for the following purposes : }For the purchase of raw materials, components and Spares. Pay wages and salaries, . . To incur day-to-day expenses and overhead costs such as fuel, power and ete, the selling costs as Packing, advertising etc. vide credit facilities to the customers, the inventories of raw material, work-in-progress, stores and ‘stock, OF ADEQUATE WORKING CAPITAL f Successfully without an adequate amount of working capi ‘of maintaining adequate amount of working capital are as Adequate working capital helps. —_ uninterrupted flow of production. t mt working capital enables a business Conce™ Ips in creating and maintaining gooow™ ncy and having adequate working capital, bi oe from banks and other financial 1 make vail toa capital also enables a conce™™ Fit reduces costs. | Sufficient working capital ensures regulaManagement of Working Capital 95 a 6, Regular payment of salaries, wages and other day-to-day commitments : A company which has ample working capital can make regular payment of salaries, Wages and other day-to-day commitments which raises the morale of its employees, increases their efficiency, reduces wastages and costs and enhances production and profits, K <7. Exploitation of favourable market conditions : Only concerns with adequate working capital can exploit favourable market conditions such as purchasing its requirements in bulk when the prices are lower and by holding its inventories for higher prices. S-Ability to face crisis : Adequate working capital enables a concern to face business crisis in emergencies such as depression because during such periods, gencrally, there is much pressure on working capital. S +Quick and regular return on investments : Every Investor wants a quick and regular return on his investments. Sufficiency of working capital enables a concern to pay quick and regular dividends to its investors as there may not be much pressure to plough back profits. This gains the confidence of its investors and creates a favourable market to raise additional funds in the future. High_morale : Adequacy of working capital creates an environment of security, confidence, high morale and creates overall efficiency in a business. EXCESS OR INADEQUATE WORKING CAPITAL Every firm must have adequate working capital. It should have neither the excessive working capital nor inadequate working capital. Both situations are risky and may have dangerous outcome. However, out of the two, it is the inadequacy of working capital which is more dangerous from the point of view of the firm. Disadvantages of Redundant or Excessi 4 -1-Excessive Working Capital means idle funds which earn no profits for the business and hence the business cannot earn a proper rate of return on its investments. “When thece is 2 redundant working capital, it may lead to unnecessary purchasing and accumulation of inventories causing more chances of theft, waste and losses. working capital implies excessive debtors and defective cre: ‘cause higher incidence of bad debts. into overall inefficiency in the organisation. is excessive working capital, relations with banks and other may not be maintained. ‘Fate of return on investments, the value of shares may also fall. working capital gives rise to speculative transactions. u 0 deqn Working Capital. ‘has inadequate working capital cannot Pay its short-term , lose its reputation and shall not be able to get good dit policy nents in bulk and cannot avail of discounts, etc. i¢ firm to exploit favourable market conditions and to lack of working capital. o-day expenses of its operations and it creates € profits of the business.ox Financial Mana St becomes impossible to utilise efficiently the fixed assets due to non-availability of liquid funds, @The rate of return on investments also falls with the shortage of working capital : FACTORS AFFECTING WORKING CAPITAL There is no sct of universally applicable rules to ascertain working capital needs of a business organisation, Since, it varies from firm to firm, industry to industry and even in the different seasons of the same firm. Therefore, a large number of factors influence the requirement of working capital, i¢., it depends upon a host of factors. They are discussed here under one by one 1. Nature and Size of Business ; The requirements of working capital of a firm videly related to the nature and size of the business unit. For example, trading and incial firms require a large amount of investment in working capital but a significantly smaller amount of investment in fixed assets. Similarly, a service oriented firm, c.g. transport or electricity generation, aceds a modest working capital requirement since it has a very short operating cycle and sales are made on cash basis. But in the case of manufacturing concern which sells its product on credit basis and has a Jong operating cycle, needs a large amount of working capital. Moreover, the size of the firm is also an important factor. Because, a smaller firm needs smaller amount of working capital on the basis of its production activities and vice-versa in the opposite case. ' 2. Length of Production Cycle : The time taken to convert raw matcrials into finished products is known as the production cycle. The level of working capital depends upon the production cycle. Longer the production cycle, more will be the need for working funds in order to finance the current assets during the prolonged manufacturing cycle, On the other hand, if the production cycle is shorter, the requirements of working capital will also be less. 3. Seasonal Operations : If a firm is operating in goods and services having scasonal fluctuations in demand, then the working capital requirement will also fluctuate with every change, In a cold drink factory, the demand will certainly be higher during summer season and therefore, more working capital is required to intain higher production, in the form of larger inventories and bigger receivables. 1 the other hand, if the operations are smooth and even through out the year then ing capital requirement will be constant and will not be affected by the Cycle Fluctuations ; Different phases of business cycle, i.e., boom, ry etc. also affect the working capital requirement. In case of boom ary Pressure appears and business activities expand. As a result, creases resulting in more and more funds it assets. In case of recession period however, there is usually ities and there will be an opposite effect on the level of There will be a fall in inventories and cash requirement ? The market competitiveness has an important eds of a firm. In view of the competitive conditions may have to offer liberal credit terms to the en larger inventorics may be maintained toManagement of Working Capital 97 = serve an order as and whan received; otherwise the customer may go to some other supplier, Thus, the working capital tends to be high as a result of greater investment in inventories and receivable, On the other hand, a monopolistic firm may not require larger working capital, It may ask the customers to pay in advance or to wait for some time after placing the order. . _b-Credit Policy ; The credit policy means the totality of terms and conditions on Which goods are sold and purchased. A firm has to interact with two types of credit policies at a time. One, the credit policy of the supplier of raw materials, goods ctc., and two, the credit policy relating to credit which it extends to its customers. In both the cases, however, the firm while deciding its credit policy, has to take care of the credit policy of the market. For example, a firm might be purchasing goods and services on credit terms but selling goods only for cash. The working capital requirement of this firm will be lower than that of a firm which is purchasing cash but has to sell on credit ba 7, Supply Conditions : The time taken by a supplier of raw materials, goods etc., alte# placing an order, also determines the working capital requirement. If goods are received as soon as or in a short period after placing an order, then the purchaser will not like to maintain a high level of inventory of that goods. Otherwise, larger inventories should be kept eg., in case of imported goods. It is often scen that the i shopkeepers may not be keeping stock of all items, but whenever there is a demand, | they re from the wholesaler/producer and supply it to their customers. forking Capital Cycle. In a manufacturing concern, the working capital cycle starts with the purchase of raw material and ends with the realisation of cash from the sale of finished products. This cycle involves purchase of raw materials and stores, its conversion into stocks of finished goods through work-in-progress with progressive increment of labour and service costs, conversion of finished stock into sales, debtors and receivables and ultimately realisation of cash and this cycle continues again from cash to purchase of raw material and so on. The speed ‘vith which the working capital completes one cycle determines the requirements of working capital, longer the period of the cycle larger is the requirement of working capital. _9¢Growth and Diversification of Business : Srowth and diversification of business call for larger volume of working fund. The need for increased working capital does not follow the growth of business operations but precedes it. Working capital need is in fact assessed in advance in reference to the business plan. ‘10:Banking Relations : A good bank-customer relationship is a pre-requisite of a successful working caj management policy. Commercial banks these days finance the working capital gap (based on set norms by Tandon and Chorey ees) credit Authorisation scheme has also been liberalised after 1986. Thus ‘receive an assured bank finance which minimises the need for making ent in current asscts. : Changes in the price level also affect the working erally, the rising prices will require the firm to maintain capital as more funds will be required to maintain the same effect of rising prices may be different for different firms. Some ed much while some others may not be affected at all by the riseae Financial Management 12-Other Factors; Certain other factors such as operating efficiency, taxation policy, dividend policy, etc., also influence the requirements of working capital. Thus, the working capital requirement of a firm is determined by host of factors. Every consideration is to be weighted relatively to determine the working capital requirement. Further, the determination of working capital requirement is not once a while exercise, rather a continuous review must be made in order to assess the working capital requirement in the changing situation. There are various reasons which may require the review of the working capital requirement e.g., change in credit policy, change in sales volume etc. SOURCES OF WORKING CAPITAL _ A firm can arrange working capital from the following two sources : Long-term sources and . 2-Short-term sources. _LlLong Term Sources : The sources of long-term financing can be broadly classified into the following two categories : ed Sources : Owned sources include the following : (i) WSue of Shares : Arrangement of working capital through issue of shares does not create a fixed obligation on incomes of the business. Thus it is referable to arrange the permanent working capital through issue of shares. (iy Retained Earnings : A firm can mect its working capital requirement by reinvesting the profits earned by it. Reinvestment of the earned profit is a -gular and cost less source of funds. (iif Reserves : Like retained earning’, the use of reserves for financing the jorking capital requirement is also a costless source of finance. (BY Borrowed Sources :.It mainly includes the issue of debentures or long-term loans. lort-term Sources : For financing the working capital requirements short ’ term sources can be classified into the following two broad categories : _ Mustraion 1 From the following informations given below, prepare an estimate gx OOF working capital requirements by projected Balance Sheet Method : a Ww (Rs.) ¥ Issued share capital 4,20,000 F 6% Debenture £ 80,000 Fixed Assets at cost 80,000 The expected ratios of cost to selling price are : Raw Materials 50% . Labour 20% Overheads 20% Profit 10% Following further informations are available : ( Raw materials are kept in store for an average period of two months ; (ii) Finished goods remain in stock for an average period of three months ; ii) Production during the previous year was 1,80,000 units and it is planned to ~ maintain the same in the current year also ; okTe eee is Financial Management (iv) Bach unit of production is expected to be in process for half a month ; (v) Credit allowed to customers is three months and given by suppli months ; (vi) Selling price is Rs. 10 per unit ; (vii) There is a regular production and sales cycle ; (viii) Calculation of debtors may made at selling price. is Wo Solution. Projected Balance Sheet Liabilities Assets Share Capital Fixed Assets 80,000 6% Debenture 80,000 |Current Assets : Profit and Loss A/c 1,175,200 |Stock : Rs. Current Liabilities + Raw Materials 1,50,000 Creditors 1,50,000 | Finished Goods 4,05,000 Bank Overdraft (Balancing figure) | 3,27,300 | Work-in-Progress 67,500 | 6,22,500 Debtors Working Notes : (i) Calculation of Profit Rs. Rs. Sales (1,80,000 Units @ Rs. 10 per unit) 18,00,000 © Material (18,00,000 x 50%) 9,00,000 Labour (18,00,000 x 20%) 3,60,000 Overheads (18,00,000 x 20%) 3,60,000 16,20,000 Gross Profit (being 10% of Sales) 7,80,000 (© Debenture Interest (assumed as being paid) (80,000 x 6%) 4,800 Net Profit 775,200 ~ Gi) Debtors = 18,00,000 x 3 = Rs. 4,50,000 ii) Calculation of Stock of Eee A (2 Months) : 18,00,000 x 20 x 2 2 = Rs. 150,000 _____ Gv) Calculation of Stock of Finished Goods G Monti) Rs. Nospon ¥40y Raw Material (18.00.00 x = 2 x 2 2,25,000Management of Working Capital 9.13 Overheads (18,00,000 x 22 1} 000 « 20. 15,000 Total Rs. 67,500 (vi) Calculation of Creditors (2 Months) : 18,00,000 x 2 x Z = Rs. 1,50,000 (vii) Calculation of Required Working Capital: Current Assets : Stock (Calculated as above) Debtors (© Current Liabilities : Rs. Creditors 1,50,000 Bank Overdraft 3,27,300 477,300 Note: It has been assumed that labour and overheads have been incurred in the beginning of the period. Hence, the whole (full) amount of labour and overhead has been included in work-in-progress. 4. Forecasting of Current Assets and Current Liabilities Method : This is the most popular method of estimating the working capital requirement. It has already been stated that the working capital is the difference between current assets and current liabilities. In order to estimate the requirements of working capital one has to forecast the amount of current assets and current liabilities. Generally we make the estimate on the basis of past experience related to production process, credit policy and stock policy. In brief, the following points are taken into consideration at the time of estimating the amount of current assets and current liabilities : . (i) The total number of units to be manufactured throughout the year ; SP? Gi) The cost of raw materials, wages and overheads for each unit; \. ii) Information about the period during which raw materials will remain in stock Son an average before the same arc issued to production ; ') Information about the period during which the product will be processed in the factory ée,, the length of the production process ; (v) Information about the period during which finished products will remain in the warchouse before sale ie., the length of sales cycle ; (vi) Information about the period of credit allowed to debtors ; (vii) Information about the period of credit allowed by suppliers ; (vii) Information about the lag in payment of wages and overheads. Estimation of Current Assets : 1. Stock of Raw Materials : =Budgeted Cost of raw Average inventory qi Production X materials x holding period (inunits) __per unit (months/days) e 72 months/365 days ai 2. Work-in-progress + = Budgeted production x Estimated Work- x Average time span - (inunits) in Process cost of work-in-progress per unit inventory (months/days) set mont ysee ge in Financial Management O14 43, Finished Goods Inventory : | = Budgeted Xx Cost of goods X Finished Goods Production produced per unit holding period (in units) (excluding depreciation) _(months/days) 12 months/365 days Debtors : The amount of funds locked up in sundry debtors will be computed cate basis of credit sales and the time-lag in collecting payment. _ /= Budgeted x Cost of sales x Average debt Credit sales per unit excluding collection period (inunits) depreciation (months/days) 12 months/365 days - Note: Stock and debiorsshould-be takerrat cost unless otherwise required in a given question, $, Cash and Bank Balance : Apart from working capital needs for financing inyentorics and debtors, firms also find it useful to have some minimum cash balances . with them. It is difficult to lay down the exact procedure of determining such an amount. The amount to be kept as cash in hand or cash at bank can be estimated on the basis of past experience. Every businessman knows the amount that he will require for mecting his day-to-day payments. Estimation of Current Li: 1, Sundry Creditors : The lag in payment to suppliers of raw materials, goods, etc., and likely credit purchases to be made during the period will help in estimating the amount of creditors. Symbolically : = Budgeted Cost of raw Credit period yearly production x “materials x allowed by creditors (in units) per unit (months/days) , 12 months/365 days Note : Proportional adjustment should be made to cash purchase of raw materials. 2. Outstanding Direct Wages : = Budgeted Direct wages Average time-lag - Production xX perunit’ x in payment of wages (in units) ‘months/days) 12 months/365 days ig Overheads (other than depreciation) : go Budgeted . Overhead Cost Average time-lag in ‘production perunit payment of overheads (months/days) 12 months/365 days ‘may be separately calculated for different types of overheads. the relevant item would be sales volume instead of ets and current liabilities as above, we find out and total current liabilities. This difference In order to provide for contingencies, 7; Percentage of the working caj capital ae i ion helps in adjusting al |a Management of Working Capital =, f In brief, the computation of working capital is summarised in the following format ; Statement Showing Working Capital Requirements Amount oor Assets : oe ‘Stock of Raw Materials (for ...... months consumption) eo | SB) Work-in-Process (for ....... months) ; (a) Raw Materia? | (b) Direct Labour | (©) Overheads } iti) Stock of Finished Goods (for ....... month’s sales) = (a) Raw Material (b) Labour (c) Overheads, Se Sundry Debtors or Receivables (for. (a) Raw Material (b) Labour (©) Overheads W) Payments in Advance (if any) : : (vi) Balance of Cash (required to meet day-to-day expenses) : Ail) Others (if any) month's sales) : _ months’ purchase of Raw Material) (ii) Lag in payment of expenses (Outstanding expenses ...... month's) ‘Others (if any) a ‘Net Working Capital (C.A. - CL.) ‘Add + Provision for Contingencies ‘Total Working Capital Required The following information has been submitted by a borrower : IMlustration 2. (i) Expected level of annual production. ‘ 2,40,000 units *~ Gi) Raw Material to remain in stock on an average #2 months (iii) Processing Period ? 1 month 3 months iv) Finished goods remain in stock on an average () Credit allowed to the customers from the date of despatch “3 months Expected fatio of cost to selling price: a fa) Raw Material, ©, 60% ot 10% | B02 BB} “52% i; Rs. 20 “ 10% (Kurukshetra, B. Com., 1990) it Showing Working Capital Requirements Amount Rs. 4,80,0009.16 (ii) Work-in-Progress (Processing period 1 month) Raw Material (2,40,000 x 1) 2,40,000 Direct Labour —_—_(40,000 x 1) 40000 Overheads (80,000 x 1) 10,000 | 39699 (iii) Finished Goods (Average Storage Period 3 months) a ' Raw Material —_(2,40,000 x 3) 720,000 Direct Labour (40,0003) v=, + 120,000 Overheads (80,000 x 3) a 240,000 | 10,8009) . (iv) Debtors (Average Collection Period 3:months) Sama Raw Material —_(2,40,000 x 3) 7,20,000 Direct Labour (40,000 x 3) 1.20,000 Overheads (80,000 x 3) 240,000 | 1080,000 Estimated Total Re The monthly amount of each element of cost has been calculated’as follows : Total Sales (2,40,000 units x Rs. 20 per unit) = Rs. 48,00,000 \ ~ Monthly Expenditure on Raw Material (4g, 00,000 x +5, x i 2] =Rs.2,40,000 Monthly Expenditure on Direct Wages {48,00,000 x 0.x #| =Rs. 4000 ; : a Mes Monthly Overhead 48,00,000 x 95 * s =Rs. 80,000 ; Note: (1) As the average payment period for raw material purchases'has not been given in the problem it is presumed that the firm has to pay immediate cash for such purchases and-there are no creditors for raw material. Debtors have been estimated at cost of sales. ! tration 3, The following projections have been presented for consideration before the eee of the company for the year 2004 : @A Annual, Re in stsed and Materials Rs. 9,600; Office Salaries Rs. 12,480; as Rs. 2,000; Other Expenses Rs. 9,600 ~(@) Average amount of stock to be maint ed Ra Stock of Finished Goods - ei a 1600 ace) Be ue7 Management of Working Capital 917 eee Solution, Statement Showing Working Capital Requirements TT eee (A) Curent Assets : Rs. (i Stock of Materials and Stores (as given) on (ii) Stock of Finished Goods (as given) 1,000 (iii) Debtors : (a) Home Market («200 «| 7,200 (b) Foreign Market (15600 x ial 450 | 7,650 | (iv) Advance Payment of Expenses (1600 x al 400 ‘Total Investment in Current Assets 10,650 (B) Current Liabilities : (@ Creators for stores and materia (3600 x 13) 1,200 (ii) Outstanding Expenses : 1s ‘Wages (52.000 x Fal 1,509 Office Salaries {1280 <7) $20 6 Rent (2000 x4) : 1,000 Other Expenses (>600 x | 1200] 4,220 ‘Total estimate of Current Liabilities aaa ‘Amount of Required Working Capital (A) ~ (B) pee {10,650 - 5,420) \fllusiration 4, Below are given the per unit selling price, costs and profit for Doaba Enterprises Limited : Details Per Unit Rs. a Raw Material eT Direct Labour sao?" Overheads ‘ > Total Cost ——7—> = AQ eS 1a i 500 ‘The additional informations available are as follows : (i) The Company sells goods to its customers on 2.months credit and purchases 7 gw material from ils suppliers on, fonth crédit. © * ye storage period is 1 month for raw material, 1/2 month for \d 1. month for'filished goods. mn yin paysmentis 1/2 month for wages and 1 month for overheads. outs sld agains, 3" ; 1 sum of Rs, 50,000 is kept as cash. — the compariy has made out plan to manufacture 36,000; = yoar, and sales of the company are evenly spread over throughout the year. O1.02ee ‘os to eee Financial Management O18 that 5% of the working capital is kept as additional fund for _Assumint re required to work out an estimate of the total requirements for ontingene coe capital by the company. Solution. . Estimate of Total Working Capital Requirements TAY Cent Assets a ie | (i) Raw Material (Storage Period 1 month) 36,000 x 160 x #5} 4,80,000 (oom 000 x 400 "a 6,00,000 (iy Worksn-Progress (Losk-up Period 1/2 month) 36,000 x'400 x 4 12,00,000 (iti) pee Goods (Storage Period.1 month) ‘27/000 x 400 x 2} 18,00,000 (Debtors (Crepit 2 months) (v) Cash Balance Total Current Assets 41,30,000 ~(B) Current Liabilities : A (i) Creditors (Credit 2 months) 36,000 x 160 x fal 100 (ii) Labour (Time-lag 1/2 month) 36,000 2100 x «3] (iiiy Overheads (Time-lag 1 month) 36,000 x 140 <7] Total Current Liabilities (C) Net Working Capital (A) - (B)» (D) Add ; 5% for Contingencies (25 (00,000 x a ‘Total Requirements for Working Capital i Working Notes : (@ Credit Sales = 36,000 x 3 = 27,000 units, (ii) Cost of Sales for Debtors = (27,000 x 400) = Rs. 1,08,00,000. | Note: (1) It has been assumed that material, labour and overheads are spent fully at the beginning of production process. Alternatively, it may be assumed that the labour and 4 overheads is evenly incurred during production. In that case, on average basis, about and overheads would be included in work-in-progress for only half the time and the total amount locked in work-in-progress will be calculated as follows : sal = 36:000X160X1 0 _ Raw Material ae Rs. 2,40,000 Direct Labour =. 36,000 X100X1X1 Rs 75,000 ) 12 22 ES aKa? = Rs, 1,05,000 “Rs 20000 ‘Cost of sales. _ ; d of Directors of Littlemore & Co. that will be required to meet the m the following information, prepare da forecast Profit & Loss AccountManagement of Working Capital 9.19 e Rs. Issued Share Capital > 2,00,000 Debentures > i 50,000 Pixed Assets as on Ist January» 1,25,000 Production during the previous year was 60,000 units and it is proposed to maintain the same during 2004. The expected ratios of cost to selling price arc : raw materials 60%, direct wages 10%, overheads 20%, Following further informations are available : ~{i), Raw materials are expected to remain in stores for an average of two months before issue to production. + Gi) Each unit of production is expected to be in process for one month (i)_Finished goods will remain in the warehouse awaiting dispatch to customers for approximately three months. +4) Credit allowed by creditors is two months from the date of delivery of raw k atrial. = oy Credit given to debtors is three months from the date of dispatch. (vi) Selling price is Rs. 5 per unit; ~ (vii) Sales and Production follow a consistent pattern. / (Meerut, 1997 Back Paper) Solution. i” é Statement Showing Working Capital Requirements (A) Current Assets : Rs. Rs. (i) Stock of Raw Materials (2 months) : (Rs. 15,000 x yw 30,000 (ii) Stock of Finished Goods (3 months) : Materials (Rs. 15,000 x 3) 45,000 Labour (Rs. 2,500 x 3)” 7,500 Overheads (Rs. 5,000 x 3) 15,000_| 67,500" (iii) Work-in-Progress (1 month) : : Materials (Rs. 15,000 x 1) - 15,000 Labour (Rs. 2,500 x 1) 1 2,500 Overheads (Rs. 5,000 x 1) 5,000 22,500 (iv) Debtors (3 months) : \ Materials (Rs, 15,000, 3) 45,000 q Labour (Rs. 2,500 £3). - 7,500 . ‘ Overheads (Rs. 5,000 x 3) 15,000 | 67,500 1,87,500 Less : Current Liabilities = Creditors for Raw Materials (2 a ' ly amount of each element of cost has been calculated as follows : Sales = (60,000 units x Rs, 5 Per unit) = Rs. 3,00,000 Raw Material = 3:20,000 x 60 _ : 100 x 12 — ee‘To Direct Labour Direct Labour Overhead 2, It has been assumed that labor of production process. Alternatively, is evenly incurred ; overheads would be included in work-in- 3, Debtors have been estimated at cost of sales. Forecasted P. & L. Account = 60 To Materials {60,000 x 5 x al 1,80,000. 10 60,000 x 5 x 100) 30,000 “To Overheads 20, 60,000 x 5 x | > Gross Profit fd ‘To Debenture Interest ~ 8 50,000 x a ‘To Net Profit Share Capital Profit & Loss A/c 8% Debentures Creditors Financial Management 00,000 10 _ PE = "100 x 12 Rs. 2,500 3,00,000 x 20 = SOO UN ae = 70x12 ~ Rs. 5,000 ur and overheads are spent fully at the beginning it may be assumed that the labour and overheads during production. In that case, on average basis, labour and progress for only half the time. 3,00,000 By Sales (60,000 x 5) 3,00,000 By Gross Profit b/d 30,000 Fixed Assets [Current Assets : Stocks : Rs. Raw Materials 30,000 Work-in-Progress 22,500 67,500 © 36,500 151,000 ion, prepare a statement showing the ‘Solvent Ltd. taking 360 days in a ydar inits at Rs. 2 per unit. Production n evenly throughout the ycar andpoe ee Management of Working Capital 921 Materi: ; ernst Re. 1 per unit abour i Re, 0.40 per unit Overheads Re, 0.35 per unit as Customers are given 45 day's credit and 60 day's credit is taken from suppliers. 36 day's supply of raw materials and 15 day's supply of finished goods arc kept. Production cycle is 18 days and all matcrials is issued at the commencement of cach production cycle. A cash balance equivalent to one-third of the average of other working capital — is kept for contingencies. (Meerut, 1991 Regular) ion. Statement Showing Working Capital Requirements Current Assets to be maintained : a Stock of Raw Materials (s ,00,000 x eal 50,000 Stock of Finished Goods (5:0000 Units x Rs. 1.75 Per Unit 3a) 36,458 43,750 Work-in-Progress (5.00.00 x 1.75 x 3) Del AS. tors: (500.000 * 1.75 x 360 1,09,375 ‘Total Current Assets excluding Cash | 2,39,583 Less : Current Liabilities to be created : Creditors (5:00.00 x &) 83,333 Other Working Capital Requirement excluding Contingencies 156,250 52,083 “Add + Cash for Contingencies 6 x 156250) Required Working Capital Working Notes : (A) Ithas been assum ed that labour and overheads are spent fully at the beginning of production process. ‘Alternatively, it may be assumed that the labour and overheads & evenly incurred during production. In that case, on average basis, labour and overheads would be included in work-in-progress for only half the time, ie., for 9 days only. In that case, the total amount locked up in work-in-progress will be calculated as follows : ‘ Material 5,00,000 x 1 x 3 = Rs. 25,000 Labour 500,000 x 0.40 x 325 = Rs. 5,000 Overhead 500,000 x 035 x 325 = Rs. 4375 Rs. 34,375 2) Debtors have been estimated at cost of sales. tion 7. X & Co. is desirous to purchase a business and has consulted you ‘one point on which you are asked to advise them is the average amount of workin, 300 x 35» Fi 00000 spn (4 weeks) 52,000 x 850 x 5 at cost (8 weeks) 52,000 x 850 x x5 ‘Total Current Assets (4 weeks) $2,000 x 400 x xre ge ee eee aan Financial Management = 51280 © 60 days Operating Cycle Period = 100 + 40 + 30 + 36 = 60 = 146 days ; : f No. of Days in a y (2) No. of Operating Cycles per year = Fon ‘of Operating Cycle (3) Total Cash Operating Expenses in the year : Cost of Goods Sold (Calculated as above) Rs. 1,46,000 (~) Depreciation Rs.__ 3,400 1,42,600 = —Total Cash Operating Expenses ie Dink Oana = (4) Required Working Capital No. of Operating Cycles per year = 142,000 _ Rs 57,040 2-5 Examination Questions Long Answer Theoretical Questions 1. What is meant by Working’ Capital? How would you determine the working capital requirements? 2. What is ‘Operating Cycle’ of working capital? How will you determine the amount of working capital under this method? Explain with examples. 3. Discuss the internal and external sources of financing working capital requirements of a firm. 4. What is meant by Working Capital? Enumerate the various factors which affect the demand for working capital in a business concern. $. Define Working Capital. How will you estimate the working capital requirements of a concern? 6. “Inadequate working capital is disastrous whereas redundant working capital is a criminal waste.” Critically examine this statement. 7. What do you mean by management of Working Capital? Explain its importance in finance function. 8. Explain the concept and determinants of Working Capital. - (Rohilkhand, M. Com., 1995) 9. Define Working Capital. Explain its different sources. 10. Explain the different techniques of analysing the Working Capital. (Rohilkhand, M. Com., 1994) 11. What is meant by working capital forecast? Briefly cxplain the techniques used in making such forecast. (Meerut, M. Com., 2001 Back) Short Answer Theoretical Questions _ 1. What is quantitative concept of working capital? * 2. What is qualitative concept of working capital? 3. Discuss the kinds of working capital, 4. What is the importance of working capital? 5. What is operating cycle method of estimating working capital?Management of Working Capital 9.39 zu ne 12. LAS MW 1 What are the advantages of adequate working capital? Explain various factors influencing working capital Explain the different sources of working capital What is working capital? What do you mean by management of working capital? What are the internal sources of working capital? What are the long-term sources of working capital? How can the working capital needs of a concern be determined? How operating cycle period is calculated? Objective Questions State whether the following statements are true or false : Gross working capital refers to the capital invested im the total assets of an enterprise. (False) Net working capital is the excess of current liabilities over current assets. (False) Every business concern should have excessive working capital. (False) Net working capital is that portion of a firm’s current assets which is financed by long-term funds. (True) Longer the process period of manufacture, larger is the amount of working capital, (True) The fixed proportion of working capital should be generally financed from fixed capital sources. (True) Commerical banks provide loans for working capital. (True) In case of trading firm, the operating cycle is longer than that for a manu- facturing firm. (False) Fill in the Blanks : Total of all current assets is called. pital. Excess of current assets over current liabilities Net working capital is the excess of. e Working Captial is also known as. ' 7 The rate of return on investments.. the shortage of working capi Greater the size of a business unit. .will be the requirements of working capital. Gross Working Capital is the. approach, Ans, 1. Gross working, 2, Net working, 3, Current Assets, Current Liabilities, 4. Circulating, Revolving, 5. Falls, 6. Larger 7. Quantitative. Select the correct option from the following : Total of all current assets is called : (a) Gross working capital, ) (b) Net working capital (c) Fixed working capital ‘ (d) None of these Excess of current assets over current liabilities is called : (a) Net working capital (v) (b) Gross working capital