Estimation of Working Capital

Estimation of Working Capital

1.Introduction

The funds required by every business organization can broadly classify into fixed capital and

Working Capital. Fixed capital is needed for the acquisition of fixed asset. Fixed assets

constitute of basic tools of the means of production. Investment in fixed assets by itself is

dead investment and the funds so locked up do not circulate continuously. Every business

organization requires some funds to carry on its operations and to produce goods for sale to

earn profit. These funds which are represented by the current capital used through the various

steps of production and distribution and are invested in Current Asset.

There are two concepts of working capital viz. quantitative and qualitative. Some people also

define the two concepts as gross concept and net concept. According to quantitative concept,

the amount of working capital refers to ‘total of current assets’. What we call current assets?

Smith called, ‘circulating capital’. Current assets are considered to be gross working capital

in this concept.

The qualitative concept gives an idea regarding source of financing capital. According to

qualitative concept the amount of working capital refers to “excess of current assets over

current liabilities.” L.J. Guthmann defined working capital as “the portion of a firm’s current

assets which are financed from long–term funds.”

The excess of current assets over current liabilities is termed as ‘Net working capital’.

Concept “Net working capital” represents the amount of current assets which would remain if

all current liabilities were paid. Both the concepts of working capital have their own points of

importance. “If the objectives is to measure the size and extent to which current assets are

being used, ‘Gross concept’ is useful; whereas in evaluating the liquidity position of an

undertaking ‘Net concept’ becomes pertinent and preferable.

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Definition:

“Difference between the book value of the Current Assets and the Current Liabilities”.

- By Hoagland

The management of Working Capital is by no means an easy task but presents stimulating

challenges to the financial executive. It requires his constant attention and exercise of skill

and judgment through knowledge of business on awareness of economic trends and

familiarity with the money market.

For smooth running an enterprise, adequate amount of working capital is very essential.

Efficiency in this area can help, to utilize fixed assets gainfully, to assure the firm’s long-

term success and to achieve the overall goal of maximization of the shareholders, fund.

Shortage or bad management of cash may result in loss of cash discount and loss of

reputation due to non-payment of obligation on due dates. Insufficient inventories may be the

main cause of production held up and it may compel the enterprises to purchase raw materials

at unfavorable rates.

Working capital has acquired a great significance and sound position in the recent past for the

twin objects of profitability and liquidity. In period of rising capital costs and scare funds, the

working capital is one of the most important areas requiring management review. It is rightly

observed that, “Constant management review is required to maintain appropriate levels in the

various working capital accounts.” Mainly the success of a concern depends upon proper

management of working capital so “working capital management has been looked upon as

the driving seat of financial manager.” It consumes a great deal of time to increase

profitability as well as to maintain proper liquidity at minimum risk. There are many aspects

of working capital management which make it an important function of the finance manager.

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In fact we need to know when to look for working capital funds, how to use them and how

measure, plan and control them.

2.Types of Working Capital

Working Capital is divided into various types based balance sheet view and operating cycle

view. Balance sheet view divides working capital into gross working capital and net working

capital and the operating cycle view divides the working capital into permanent and

temporary working capital. Permanent working capital is further divided into seasonal and

special working capital whereas temporary working capital into regular and reserve working

capital.

Working capital is the capital / funds required for day to day operations of the business.

Working capital is invested usually in all types of inventories such as raw materials, spares,

finished goods etc. and credit extension to debtors and cash in hand.

Types of Working Capital:

Working capital is classified into different types and the classification is based on the

following views:

1. Balance Sheet View

2. Operating Cycle View

On the basis of Balance Sheet View, types of working capital are described

below:

Gross Working Capital (GWC):

Current assets in the balance sheet of a company are known as gross working capital.

Current assets are those short term assets which can be converted into cash within a

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period of one year. The grey area in the management of current assets or gross

working capital is its unpredictability i.e. it is very difficult to ascertain the exact time

of conversion of such assets. Why such a nature is problematic? It is because the

liabilities occur at their time and do not wait for our current asset to realize. This

mismatch or the gap creates a need for arranging working capital financing.

Net Working Capital (NWC):

Net working capital is a very frequently used term. There are two ways to understand

net working capital. First one says it is simply the difference of current assets and the

current liabilities in the balance sheet of a business. The other understanding

discloses little deeper or hidden meaning of the term. As per that, NWC is that part of

current assets which are indirectly financed by long term assets. Compared to gross

working capital, net working capital is considered more relevant for effective

working capital financing and management.

On the basis of Operating Cycle View, types of working capital are as

below:

Permanent / Fixed Working Capital:

Dealing with current asset and fixed assets is totally different. Determining the

financing requirement in case of fixed assets is simply the cost of the asset. Same is

not true for current assets because value of current assets is constantly changing and

it is difficult to accurately forecast that value at any point of time. To simplify the

complexity to some extent, on the basis of past trend and experience, we can find a

level below which current asset has never gone.

Temporary / Variable WC:

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Temporary working capital is easy to understand after getting hold over permanent

working capital. In simple terms, it is the difference between net working capital and

permanent working capital. The main characteristic which can be made out from the

example is “fluctuation”. The temporary working capital therefore cannot be

forecasted. In the interest of measurability, this can be further bifurcated as below

which can create at least some base to forecast.

a) Seasonal Working Capital:

Seasonal working capital is that temporary increase in working capital

which is caused due to some relevant season for the business. It is

applicable to businesses having impact of seasons for example,

manufacturer of sweaters for whom relevant season is the winters.

Normally, their working capital requirement would increase in that

season due to higher sales in that period and then go down as collection

from debtors is more than sales.

b) Special Working Capital:

Special working capital is that rise in temporary working capital which

occurs due to a special event which otherwise normally does not take

place. It has no basis to forecast and has rare occurrence normally. For

example, country where Olympic Games are held, all the business require

extra working capital due to sudden rise in business activity.

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3.Working Capital EstimationParticular Particular Particular Base 2013 2014

Rs. in lakhs

Rs. in lakhs % Rs.

in lakhs Rs. in lakhs

Direct raw material consumed 52.48 10529 12635Direct wages 10.01 2008 2410Direct Expenses PRIME COST 12537 15044

ADD:- factory OverheadsConsumption of Stores And Spares 105 126 0.63Repairs and Maintenance – Building 15 18 0.09Depreciation on plant & machinery 324 389 1.94Depreciation on building 219 263 1.31packing expenses 202 242 1.21freight and handling expenses 166 199 0.99Repairs and Maintenance - Plant & Machinery 225 270 1.35Power and Fuel 1913 2296 11.44

3169 3803 WORK COST 15706 18847

ADD:- Administration overheadsRent 82 82 0.41Auditors Remuneration 23 23 0.11Repairs and Maintenance – other 23 23 0.11job work expenses 50 50 0.25director's sitting fees 2 2 0.01postage , telegrams and telephones 24 24 0.12Insurance 42 42 0.21Rates & Taxes 43 43 0.21Other Expenses 635 635 3.17 924 924COST OF PRODUCTION 16630 19771

Add: selling & Distribution

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Expensesbad debts written off 14 17 0.08discount on sale 19 23 0.11provision for doubtful debts 486 583 2.91Research & development expenses 20 24 0.12marketing and promotional expenses 496 595 2.97commission on sales 559 671 3.34provision for doubtful advances 269 323 1.61Traveling &conveyance 246 295 1.47

2109 295COST OF GOODS SOLD 18739 20066

PROFIT 6.59 1322 4006.8SALES 100% 20061 24073

Working Note1:

Sales FOR 2013 20061

On Assumption Basis (increase by 20%) 24073

Working Note2:

1) Raw Materials:

Raw Materials = Closing Stock of Raw Material

Raw Material Consumed

= 1429

10529

= 50 days

2) Work – in – Progress:

Work – in – Progress = Closing Stock of Work – in – Progress

Cost of Production

= 763

7

X 365

X 365

X 365

X 365


16630

= 17 days

3) Finished Goods:

Finished Goods = Closing Stock of Finished Goods

Cost of Goods Sold

= 1496

18739

= 29 days

4) Traded Goods:

a) Traded Goods Consumed = Opening Stock + Purchase – Closing Stock = 85 + 254 – 102 = 237

b) Traded Goods = Closing Stock of Traded Goods

Traded Goods Consumed

= 102

237

= 157 days

5) Trade Receivable:

a) O/s More than 6 months = Closing Trade Receivable

Net Sales

= 6687

20061

= 122 days

8

X 365

X 365

X 365

X 365

X 365

X 365


b) Other Outstanding = Closing Trade Receivable

Net Sales

= 10930

20061

= 122 days

6) Cash & Bank Balance: Assuming that closing Balance of 2013 is to remain constant for all month

Cash & Bank Balance = Cash

No. of months

= 819

12

= Rs. 68

7) Trade Payable:

Trade Payables = Creditors

Credit Purchase

= 6388

10529

= 221 days

8) Payables for Fixed Assets: *

Payables for Fixed Assets = 434

12

= Rs. 36.17

9

X 365

X 365

X 365

X 365


9) Current maturities of long term borrowing: *

Current maturities of long term borrowing = 4407

12

= Rs. 367.25

10) Interest accrued but not due on borrowing: *

Interest accrued but not due on borrowing = 46

12

= Rs. 3.83

11) Interest accrued and due on borrowing: *

Interest accrued and due on borrowing = 275

12

= Rs. 22.92

12) Due to subsidiaries: *

Due to subsidiaries = 1066

12

= Rs. 88.83

13) Employee related liabilities: *

Employee related liabilities = 442

12

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= Rs. 36.83

14) Interest bearing securities: *

Interest bearing securities = 237

12

= Rs. 19.75

15) Advance from customers: *

Advance from customers = 665

12

= Rs. 55.42

16) Investor education and protection fund: *

Investor education and protection fund = 31

12

= Rs. 2.58

17) Other liabilities: *

Other liabilities = 309

12

= Rs. 25.75

Note: * Assumed it remains constant.

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PARTICULAR period calculation amount

CURRENT ASSETSStock -in –tradeRaw Material 50 days 1429*50/365 195.75342Work in progress 17 days 763*17/365 35.54Finished goods 29 days 1496*29/365 119.43Traded goods 122 days 102*157/365 43.90Trade receivablemore then 6 month 122 days 6687*122/365=2235.11

other trade receivable 199 days 10930*199/365=5959.10 8194.20Cash and bank balance 1 month 68

Total (A) 8657.07

CURRENT LIABILITIESTrade payable 221 days 6388*221/365 3867.80Payable on fixed assets 1 month 36.17Current maturities of long term borrowing 1 month 367.25Interest Accrued but not due on borrowing 1 month 3.83Interest accrued and due on borrowing 1 month 22.92Due to subsidiaries 1 month 88.83Employees related liabilities 1 month 36.83Interest bearing securities 1 month 19.75Advance from customers 1 month 55.42Investor education and protection fund 1 month 2.58Other liabilities 1 month 25.75

Total (B) 4527.14

NET WORKING CAPITAL (A) – (B) 4129.94

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Estimation of Working Capital

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