Estimating working capital requirements
1. Estimating working capital requirement using operating cycle method:
Problem:
X Ltd Co. wants to know working capital by operating cycle methods when :
Estimated Sales 20,000 units @ $5 P.U.
Production and Sales will remain similar throughout the year.
Production costs: M – 2.5 P.U., Labour 1.00 P.U. Overheads $17.500.
Customers are given 60 days credit and 50 days credit from suppliers. 40 days supply of raw materials and 15 days supply of finished goods are kept in store.
Production cycle is 20 days. All materials are issued at the commencement of each production cycle. 1/3 on an Average of working capital is kept as cash balance for contingencies.
Solution:
| (a). Total Op. Exp. for the year. | $ |
| R.M. 20,000 x 250 | 50,000 |
| Labor 20,000 x 1 | 20,000 |
| Overheads | 17,500 |
| 87,500 |
| (b). Period of Production cycle | Days |
| Material storage days (Pds) | 40 |
| Finished goods storage pds. | 15 |
| Production cycle storage pds. | 20 |
| Av. collection pd. | 60 |
| 135 | |
| Less: average payment (crs) | 50 |
| 85 |
(c). No. of operating cycle in the year: 365 / 85 = 4.3
(d). Working Capital = 87,500 / 4.3 = $20,349
Add: Reserve for contingencies 1 / 3 = 6,789 / 27,132
2. Using Working Capital Method
Problem
| $ | |
| Raw Material (needed) | 10,000 |
| Store Value | 16,000 |
| Average Credit givers: | |
| Local sales 2 weeks credit | 1,56,000 |
| Outside sales 6 weeks credit | 6,24,000 |
| Time lag payment: | |
| For purchase (4 weeks) | 1,92,000 |
| For wages (2 weeks) | 5,20,000 |
Contingencies Allowances = 15%
Calculate Amount of Working Capital.
Solution:
Current Assets:
| Inventories: R.M. | $10,000 | |
| Stock of Store | $16,000 | $26,000 |
Account Receivables (Drs)
Local sales = (1,56,000 x 2) / 52 = $6,000
Outside sales = (6 x 6,24,000) / 52 = $72,000
Less: Current Liabilities
Accounts Payables (Crs.) = (1,92,000 x 4) / 52 = $14,770
O/S Wages = (5,20,000 x 2) / 52 = $20,000
Add: 15% for contingencies = 10,385
Total Working Capital Required = $79,615
3. Using Cash Forecasting Method
Problem
John Trading Co. wants you to prepare a working capital forecast from the following:
Issued Share Capital: $4,00,000
8% Deb.: $1,50,000
The fixed Assets are valued at $3,00,000
Production: 1,00,000 units.
Expected Ratio of cost to selling price are: R.M. 50%, Wages: 10%, O/Heads: 25% = 85%
Raw material remains in stores for two months, finished goods remain in stores for 4 months, credit allowed by crs. 3 months from the date of delivery of goods (Rm) credit given to Drs. is 3 months from the date of dispatch. Production cycle is 2 months. Sale price per unit is $6. Production and sale are uniform during the year.
Solution
3. Using Projected Balance Sheet Method
Libro Ltd. has $3,50,000 Share Capital, $70,000 G.R., $3,00,000 Fixed Assets, $30,000 Stock, $97,500 Drs., $15,000 Crs.
It is proposed to increase the business the stock level by 50% at the end of year. Crs. are doubled. Machinery worth $15,000 is proposed to be purchased. Estimated profit during the year is $52,500 after changing $30,000 Depreciation and 50% of profit for taxation.
Advance income tax is estimated to be $45,000. Crs. are likely to be doubled 5% dividend be paid and 10% dividend for the next year to be proposed. Drs. are estimated to be outstanding for 3 months. Sales budget shows $7,50,000 as sales for the year make a working capital forecast by projected Balance Sheet Method.
Solution
| (i) Sh. Cap. | Fixed Assets | 3,00,000 | |||
| Cap. (Given) | 3,50,000 | 3,50,000 | M. Proposed Purchase | 15,000 | |
| Res. and surplus | 70,000 | Less Dep. | 3,15,000 | ||
| 17,500 | 30,000 | ||||
| Less dividend 10% | 52,500 | 2,85,000 | |||
| 52,500 | C.A. | ||||
| + Profit after tax | 1,05,000 | 70,000 | Stock 30,000 + 50% Add. Drs. 15,000 | 45,000 | |
| Less proposed Div. 10% | 35,000 | Adv. Tax 45,000 | 1,87,500 | ||
| Current liabilities | 2,77,500 | ||||
| Crs. 15,000 | |||||
| + (k) 15,000 | 30,000 | ||||
| Tax Provision | 52,000 | ||||
| Proposed Div. | 35,000 | ||||
| O/D (balance figure) | 25,000 | 1,70,500 | |||
| 5,62,500 | 5,62,000 |