MANAGEMENT ACCOUNTING

JUNE 2014
08. a) Define working capital and its significance for a firm.
5
Answer: Working capital is a financial metric which represents operating liquidity available to a business,
organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment,
working capital is considered a part of operating capital. Gross working capital equals to current assets.

The working capital is calculated as: 

Working Capital = Current Assets – Current Liabilities

To operate the functions of a firm working capital is very important. A firm is a unit of an industry to produce the
finished goods for earning profit. The importance of working capital for a firm is as below:
1. For smooth production;
2. Sufficient stock;
3. Smooth sales;
4. Bearing regular expenses;
5. Establish as a solvent firm;
6. Earning profits;
7. Creation of goodwill;
8. Wealth maximization;
9. Protection of fixed Capital;
10. Increase credit rating.

1. For smooth Production: for the smooth production of a firm healthy working capital is very important.
2. Sufficient stock: To stock sufficient raw materials working capital is very important for a firm.
3. Smooth sales: To sell produced goods working capital of a firm is required.
4. Bearing regular expenses: Various types of expenses not even related to production bears by a firm
important to have healthy working capital.
5. Establish as a solvent firm: To establish as a solvent firm working capital is an important parameter to
have.
6. Earning profit: For the optimum level of production and sales promotion working capital of a firm is
very necessary.
7. Creation of goodwill: Goodwill of a firm is the asset of it. To create goodwill of the firm working capital
plays an important role.
8. Wealth maximization: For the accelerate production goods and services a firm can earn profit increase
day by day to enhance its wealth.
9. Protection of fixed capital: For the well protection of the fixed capital of a firm consistence of working
capital is highly required.
10. Increase credit rating: Credit from a bank of financial institutions credit rating is very important.
Healthy working capital of a firm increases the credit rating.

The aforesaid explanations denote that working capital is very important for a firm.
08. b) Explain the factors affecting working capital requirements. 5

Answer: The main factors affecting working capital are as below:

1. Nature of Business: The requirement of working capital depends on the nature of business. The
nature of business is usually of two types: Manufacturing Business and Trading Business. In the case of
manufacturing business it takes a lot of time in converting raw material into finished goods. Therefore,
capital remains invested for a long time in raw material, semi-finished goods and the stocking of the
finished goods.
2. Scale of Operations: There is a direct link between the working capital and the scale of operations. In
other words, more working capital is required in case of big organizations while less working capital is
needed in case of small organizations.
3. Business Cycle: The need for the working capital is affected by various stages of the business cycle.
During the boom period, the demand of a product increases and sales also increase. Therefore, more
working capital is needed. On the contrary, during the period of depression, the demand declines and it
affects both the production and sales of goods. Therefore, in such a situation less working capital is
required.
4. Seasonal Factors: Some goods are demanded throughout the year while others have seasonal
demand. Goods which have uniform demand the whole year their production and sale are continuous.
Consequently, such enterprises need little working capital.
5. Production Cycle: Production cycle means the time involved in converting raw material into finished
product. Thus, more working capital will be needed. On the contrary, where period of production cycle is
little, less working capital will be needed.
6. Credit Allowed: Those enterprises which sell goods on cash payment basis need little working capital
but those who provide credit facilities to the customers need more working capital.
7. Credit Avails: If raw material and other inputs are easily available on credit, less working capital is
needed. On the contrary, if these things are not available on credit then to make cash payment quickly
large amount of working capital will be needed.
8. Operating Efficiency: Operating efficiency means efficiently completing the various business
operations. Operating efficiency of every organization happens to be different.
9. Availability of Raw Materials: Availability of raw material also influences the amount of working
capital. If the enterprise makes use of such raw material which is available easily throughout the year,
then less working capital will be required, because there will be no need to stock it in large quantity.
Reversely happened when the raw materials are not available anytime and anywhere.
10. Growth Prospects: Growth means the development of the scale of business operations (production,
sales, etc.). The organizations which have sufficient possibilities of growth require more working capital,
while the case is different in respect of companies with less growth prospects.
11. Level of Competition: High level of competition increases the need for more working capital. In order
to face competition, more stock is required for quick delivery and credit facility for a long period has to be
made available.
12. Inflation: Inflation means rise in prices. In such a situation more capital is required than before in order
to maintain the previous scale of production and sales. Therefore, with the increasing rate of inflation,
there is a corresponding increase in the working capital.
Problem: A newly formed company has applied for a short term Problem: A proforma cost sheet of a company provides the
loan to a commercial bank for financing its working capital following data:
requirements. You are requested by the bank to prepare an Estimated cost per unit of production is:
estimate of the requirements of working capital for that company. Costs per unit Taka
The information about the company is as under: Raw materials 52.00
Estimated cost per unit of production is: Direct labor 19.50
Particulars Taka Overheads 39.00
Raw materials 80 Total cost per unit 110.50
Direct labor 30 Profits 19.50
Overheads (exclusive of depreciation) 60 Selling price 130.00
Total cost 170 The following is the additional information available:
Additional information: Average raw materials and finished One month
Selling price Tk.200 per unit goods in stock
Level of activity 1,04,000 units of Average materials in process Half a month
production per annum Credit allowed by supplier One month
Raw materials in stock Average 4 weeks Credit allowed by debtor Two month
Work in progress (assume 50% Average 2 weeks Time lag in payment of wages One and half month
completion stage in respect of Overheads One month
conversion costs) Cash balance I expected Tk.1,20,000
Finished goods in stock Average 4 weeks One forth of the sales are on cash basis
Credit allowed by suppliers Average 4 weeks
Credit allowed by debtors Average 8 weeks You are required to prepare a statement showing the working
Lag in payment of wages Average 1.50 weeks capital needed to finance a level of activity of 70,000 units of
Cash at bank expected to be Tk.25,000 output. You may assume that production is carried on evenly
throughout the year (52 weeks) and wages and overheads accrue
You may assume that production is carried on evenly throughout similarly.
the year (52 weeks) and wages and overheads accrue similarly. Solution:
All sales are on credit basis only. Estimation of working capital requirements:
Required: Estimate the net working capital required for the (A) Investment in Inventory
company. (i) Investment in Raw 2,80,000
Solution: materials = RM (52*70,000*4)
Estimation of working capital requirements: consumption * RM 52
(A) Investment in Inventory consumption
(i) Investment in Raw (80*1,04,000*4) 64,000 period/No. of weeks
materials = RM 52
consumption * RM (ii) Investment in
consumption WIP=Cost of goods (110.5*70,000*2) 2,97,500
period/No. of weeks sold*WIP 52
consumption
(ii) Investment in (170*1,04,000*0.5* period /No. of weeks
WIP=Cost of goods 2) 3,40,000
sold*WIP 52 (iii) Investment in (110.5*70,000*4) 5,95,000
consumption finished goods=cost 52
period /No. of weeks of production* FG
consumption
(170*1,04,000*4)
(iii) Investment in 1360,000 period/No. of weeks
52
finished goods=cost Total Inventory Investment (i+ii+iii) 11,72,500
of production* FG (B) Investment in (130*70,000*0.75
consumption debtors= (Credit sale *8) 10,50,000
period/No. of weeks at cost*8)/No. of 52
Total Inventory Investment (i+ii+iii) 23,40,000 weeks
(B) Investment in (C) Cash Balance required 1,20,000
debtors= (Credit sale (170*1,04,000*8) 27,20,000 (D) Total investment in current assets 23,42,500
at cost*8)/No. of 52 (A+B+C)
weeks (E) Current Liabilities
(C) Cash Balance required 25,000 (i) Creditors=
(D) Total investment in current assets (A+B+C) 50,85,000 (Purchase of (52*70,000*4) 2,80,000
(E) Current Liabilities RM*CP)/No. of 52
(i) Creditors= (Purchase week
(19.5*70,000*1.5)
of RM*CP)/No. of (80*1,04,000*4) 6,40,00 (ii) Deffered wages= 39,375
52
week 52 0 Labor cost*CP)/ No.
(ii) Deffered wages= (30*1,04,000*1.5) of week (39*70,000*4)
Labor cost*CP)/ No. of 52 (iii) Deferred 2,10,000
week
90,000 52
overheads
(E) Total Current Liabilities 7,30,000 (E) Total Current Liabilities (i+ii+iii) 5,29,375
(F) Net working capital requirements (D-E) 43,55,000 (F) Net working capital requirements (D-E) 18,13,125