Estimating Working Capital Requirements
1. Estimating Working Capital Requirement Using Operating Cycle Method
- Estimated sales 20,000 units @ $5 P.U.
- Production and sales will remain similar throughout the year
- Production costs: Materials – 2.5 P.U., Labor 1.00 P.U., Overheads $17,500
Customers are given 60 days of credit and 50 of days credit from suppliers. The 40-day supply of raw materials and a 15-day supply of finished goods are kept in store.
The production cycle lasts 20 days. All materials are issued at the start of each production cycle. One-third of the average working capital is kept as a cash balance for contingencies.
|Total Op. Exp. For the Year||$|
|R.M. 20,000 x 250||50,000|
|Labor 20,000 x 1||20,000|
|Period of Production cycle||Days|
|Material storage days (pds.)||40|
|Finished goods storage (pds.)||15|
|Production cycle storage (pds.)||20|
|Av. collection (pds.)||60|
|Less: average payment (crs.)||50|
(c) No. of operating cycles 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
|Raw materials (needed)||10,000|
|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%
Required: Calculate the amount of working capital.
|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
John Trading Co. has asked you to prepare a working capital forecast using the following information:
- Issued share capital: $400,000
- 8% deb.: $1,50,000
- Fixed assets are valued at $300,000
- Production: 100,000 units.
- Expected ratios of cost to selling price are: R.M. 50%, Wages: 10%, Overheads: 25% = 85%
Raw materials remain in stores for 2 months, finished goods remain in stores for 4 months, the credit allowed by crs. is 3 months from the date of delivery of goods (Rm), and the credit given to Drs. is 3 months from the date of dispatch.
The production cycle is 2 months. Additionally, the sale price per unit is $6, and production and sales are uniform throughout the year.
4. Using Projected Balance Sheet Method
Libro Ltd. has $350,000 share capital, $70,000 G.R., $300,000 fixed assets, $30,000 stock, $97,500 Drs., and $15,000 Crs.
The company proposes increasing the business stock level by 50% at the end of the year. Credits are doubled and it is proposed that machinery worth $15,000 should 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 at $45,000. Credits are likely to be doubled, 5% dividends will be paid, and 10% dividends are to be proposed for the next year.
|(i) Sh. cap.||Fixed assets||300,000|
|Cap. (Given)||350,000||350,000||M. proposed purchase||15,000|
|Res. and surplus||70,000||Less dep.||315,000|
|Less dividend 10%||52,500||285,000|
|+ Profit after tax||105,000||70,000||Stock 30,000 + 50% add. drs. 15,000||45,000|
|Less proposed div. 10%||35,000||Adv. tax 45,000||187,500|
|+ (k) 15,000||30,000|
|O/D (balance figure)||25,000||170,500|
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About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.