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5 - FINANCIAL MANAGEMENT

MODULE – 5 WORKING CAPITAL MANAGEMENT 06 Hours

Working capital, factors determining working capital, Sources of working capital, estimating working
capital needs, Cash Management, Inventory Management (Only Theory). Receivables Management.

INTRODUCTION TO WORKING CAPITAL

Working capital refers to the circulating capital required to meet the day-to-day operations of
a business firm. Working capital has been described as the "life blood of any business which is apt
because it constitutes a cyclically flowing stream through the business.

According to Weston & Brigham - "Working capital refers to a firm's investment in short term assets,
such as cash amounts receivables, inventories etc."

The term "working capital" is often referred to "circulating capital" which is frequently used to
denote those assets which are changed with relative speed from one form to another i.e., starting
from cash, changing to raw materials, converting into work-in-progress and finished products, sale of
finished products and ending with realization of cash from debtors.

Gross Working Capital: In the broad sense, the term working capital refers to the gross working
capital and represents the amount of funds invested in current assets. Current assets are those
assets which in the ordinary course of business, can be converted into cash within a short period of
normally one accounting year.

Net Working Capital: In a narrow sense, the term working capital refers to the net working capital.
Net working capital is the excess of current assets over current liabilities.

Net Working Capital = Current Assets – Current Liabilities.

Current Assets = Cash in hand and bank balances. 2. Bills Receivables. 3. Sundry Debtors (less provision for bad debts.) 4.
Short-term loans and advances. 5. Inventories or stocks, 6. Temporary Investments of surplus funds. 7. Prepaid Expenses. 8.
Accrued Incomes etc.
Current Liabilities = 1. Bills Payable. 2. Sundry creditors or accounts payable. 3. Outstanding expenses. 4. Short-term
loans. 5. Dividends payable. 6. Bank overdraft. 7. Provision for taxation etc.

Characteristics of Working Capital

1. Short –term Requirement: Working capital is utilized to purchase current assets which can be
easily converted into cash in short period of time.

2. Circular Movement: Working capital is continuously transformed into cash but it again turns into
working capital. Working capital is also termed as circulating capital.

3. Permanent requirement: Working capital is a short-term capital but in order to continue the
business operations it is always required by the firm.

4. Variability: Though working capital is required permanently in a firm but the amount of working
capital required frequently changes with the changes in production level, changes in purchase, sales
level, price level etc.

5. Liquidity: Working capital can be easily converted into cash, hence it is more liquid. Firms which
maintain adequate amount or working capital finds easy to convert it into cash in time when cash is
required.
FACTORS DETERMINING THE WORKING CAPITAL
The following factors determine the amount of working capital.
A. Internal Factors
1. Nature and size of the business
The working capital requirements of a firm are basically influenced by the nature and size of
the business. A firm with large scale of operations will need more working capital than a small firm.
Similarly, Trading and financial firms have less investment in fixed assets. But require a large
sum of money to be invested in working capital. Public utility firms need less working capital and
more funds to invest in fixed assets.
2. Firm's production policy
The firm's production policy (manufacturing cycle) is an important factor to decide the
working capital requirement of a firm. The production cycle starts with the purchase and use of raw
material and completes with the production of finished goods. Larger the manufacturing cycle and
uniform production policy -larger will be the requirement of working capital.
3. Firm's credit policy
The credit policy of a firm influences the amount of working capital. A firm following liberal
credit policy to all customers require more funds for working capital. On the other hand, the firm
adopting strict credit policy and grant credit facilities to few potential customers will require less
amount of working capital.
4. Availability of credit
The working capital requirements of a firm are also affected by credit terms granted by its
suppliers - i.e. creditors. A firm will need less working capital if liberal credit terms are available from
creditors. Similarly, the availability of credit from banks also influences the working capital needs of
the firm. A firm, which can get bank credit easily on favorable conditions will be operated with less
working capital than a firm without such a facility.
5. Growth and expansion of business
Working capital requirement of a business firm tend to increase in correspondence with
growth in sales volume and fixed assets. A growing firm may need funds to invest in fixed assets in
order to sustain its growing production and sales. This will, in turn, increase investment in current
assets to support increased scale of operations. Thus, a growing firm needs additional funds
continuously.
6. Profit margin and dividend policy
The magnitude of working capital in a firm is dependent upon its profit margin and dividend
policy. To the extent the net profit has been earned in cash, it becomes a source of working capital.
Distribution of high proportion of profits in the form of cash dividends results in a drain on cash
resources and thus reduces company's working capital to that extent. The working capital position of
the firm is strengthened if the management follows conservative dividend policy and vice versa.
7. Operating efficiency of the firm:
Operating efficiency means the optimum utilization of a firm's resources at minimum cost. If a
firm successfully controls operating cost, it will be able to improve net profit margin, require less
funds for working capital purposes.
B. External Factors
1. Business fluctuations
Most firms experience fluctuations in demand for their products and services. In case of
upward swing in the economy, firm will require more funds. On the other hand, there is a decline in
economy, firm requires less working capital. Similarly, the seasonal fluctuations may also affect the
requirement of working capital of a firm.
2. Changes in the technology
The technological changes and developments in the area of production can have immediate
effects on the need for working capital. If the firm wish to install a new machine in the place of old
system, the new system can utilize less expensive raw materials, the inventory needs may be
reduced there by working capital needs.
 3. Taxation policy
The tax policies of the Government will influence the working capital decisions. If the
Government impose heavy tax burdens on business firms, they are left with very little profits for
distribution and retention purpose. Consequently, the firm has to borrow additional funds to meet
their increased working capital needs. When there is a liberalized tax policy, the pressure on working
capital requirement is minimized.

Working Capital Policy

A working capital policy outlines a company's approach to managing its short-term assets and
liabilities. It guides decisions about the levels of current assets (like cash, inventory, and accounts
receivable) and how to finance them (using current liabilities like accounts payable or short-term
loans). The main types of working capital policies are conservative, aggressive, and moderate (or
hedging).
Different Types of Working Capital Policies:
1. Conservative Working Capital Policy:
 Focused on minimizing the risk of not being able to meet short-term obligations.
 Maintaining a high level of current assets (especially cash and marketable securities)
relative to sales and current liabilities. This provides a large cushion to handle
unexpected events or shortfalls in cash flow.
 It reduces the risk of liquidity problems, higher safety margin.
 But it results in lower profitability due to holding large amounts of low-yielding assets,
opportunity costs.
2. Aggressive Working Capital Policy:
 Focused on maximizing profitability by minimizing investments in current assets.
 Holding minimal levels of current assets, potentially leading to a lower cash balance,
tighter credit policies, and lower inventory levels. This strategy often involves relying
heavily on short-term financing.
 Higher potential for profitability due to lower investment in current assets.
 But there is increased risk of not being able to meet short-term obligations, potential
for production disruptions due to inventory shortages, higher financing costs.
3. Moderate (or) Hedging Working Capital Policy:
 Focused on balancing liquidity and profitability by matching the maturities of assets
and liabilities.
 This approach aims to closely match the financing of current assets with the maturity
of the related liabilities.
 Reduced risk of liquidity problems while maintaining reasonable profitability.
 It requires careful planning and management to ensure that assets and liabilities are
properly matched.

SOURCES OF WORKING CAPITAL

1. Spontaneous Sources
As the name suggests, spontaneous sources of working capital occur naturally from day-to-day
business activities.

 Trade Credit: The most common way to raise funds for the short term, trade credit is the
credit extended by Creditors, suppliers, wholesalers, distributors, resellers, etc.

 Bills Payable / Promissory Notes: These are the instruments of delayed payments for the
goods and services that a company buys on credit.

 Accrued Expenses: Expenditures that have been accrued but whose payments are yet to be
made can also be great sources of working capital.
 2. Short-Term Sources of Working Capital
Short-term finance for working capital com with tenures of one year or less. The most prominent
sources include the following.

A. Loans from Commercial Banks

1. Short Term Loans- Also known as term loans, these sources of working capital finance
involve a straight-up lump-sum payment to businesses at an interest granted by banks.
2. Cash Credit- These short-term sources of working capital can be secured or unsecured, have
maximum repayment tenure of 1 year, and allow businesses to borrow amounts up to
a specific limit.
3. Hypothecation / Pledge Advances- Businesses put up an asset or stocks as security for a
loan in these sources of working capital. However, the said asset is still under the business’s
possession and can be used as necessary.
4. Overdraft Facility- A bank overdraft allows businesses to overdraw their current account. It
is a common source of working capital finance for companies.
5. Bill Financing- Bill financing helps businesses raise money using outstanding invoices of
transactions already made. This is a great way to unlock the credit stuck in the supply chain.
B. Public Deposits
For this particular source of working capital finance, a business can invite the public to make short
term deposits for a high rate of return. According to the Reserve Bank of India, companies can raise
up to 35% of their paid-up capital or the money received from selling stocks.

C. Bill Discounting
For these sources of working capital, outstanding invoices are sold at a discount to financial
institutions that disburse a certain percentage of the invoice amount, helping businesses meet
their temporary working capital needs.

D. Advances from Customers

One of the most common sources of working capital finance is getting an advance from customers. A
business can ask a buyer to pay a certain amount upfront and use it to meet different working capital
requirements.

E. Commercial Paper
Commercial papers are debt instruments issued on the money market by businesses looking to meet
their short-term financial requirements.

3. Long-Term Sources of Working Capital

Long-term sources of working capital come with tenures of more than one year and include the
following:

 Share Capital
The total amount of capital a company possesses by selling its shares is among the primary external
sources of working capital finance.
 Long-term Loans
Banks and NBFCs grant long-term loans to businesses with repayment tenures of 7 years. However,
due to long tenures, they are not considered ideal sources of working capital financing.
 Debentures
Debentures are unsecured long-term debt instruments issued by companies with a solid financial
reputation. The company is obligated to pay interest to the lender no matter the circumstances.
ESTIMATING WORKING CAPITAL NEEDS

Estimation of working capital requirements should be made in advance so that arrangements can be
made to procure adequate working capital.
Methods of Estimating Working Capital Requirements:

The following method are used in forecasting working capital requirements of a firm

1. Percentage of Sales Method

2. Regression Analysis Method
3. Cash Forecasting Method
4. Operating Cycle Method
5. Projected Balance Sheet Method

[Link] of Sales Method

This method of estimating working capital requirements is based in the assumption that the
level of working capital for any firm is directly related to its sales value. If past experience indicates a
stable relationship between the amount of sales and working capital, then this basis may be used to
determine the requirements of working capital for future period.
2. Regression Analysis Method (Relationship between Sales and Working Capital)
This method of forecasting working capital requirements is based upon the statistical
technique of estimating or predicting the unknown value. It is the measure of the average
relationship between two or more variables, i.e., sales and working capital, in terms of the original
units of the data.
3. Cash Forecasting Method
This method of estimating working capital requirements involves forecasting of cash receipts
and disbursements during a future period of time. Cash forecast will include all possible sources
from which cash will be received and the channels in which payments are to be made so that a
consolidated cash position is determined.
This method is similar to the preparation of a cash budget. The excess of receipts over
payments represents surplus of cash and the excess of payments over receipts causes deficit of
cash or the amount of working capital required.
4. Operating Cycle Method
This method of estimating working capital requirements is based upon the operating cycle
concept of working capital. The cycle starts with the purchase of raw material and other resources
and ends with the realization of cash from the sale of finished goods.
The speed/time duration required to complete one cycle determines the requirement of working
capital, longer the period of cycle, larger is the requirement of working capital and vice-versa.
5. Projected Balance Sheet Method
Under this method, projected balance sheet for future date is prepared by forecasting of
assets and liabilities. The excess of estimated total current assets over estimated current liabilities,
as shown in the projected balance sheet, and the estimated amount of working capital is calculated.

CASH MANAGEMENT
Management of cash is an important function of the finance manager. It is concerned with
management of cash in efficient and in effective manner. Organizations need to maintain cash for
their daily requirements and this level of cash has to be set after analyzing operating cycle of the
particular organization. Larger the operating cycle large amount of cash will be required and vice
versa. Cash management becomes necessary to maintain liquidity & solvency in business and to
avoid situations of holding more cash or shortage of cash.
The following are the four motives or purposes for holding cash:
1. Transaction needs: - Cash facilitates the meeting of the day-to-day expenses and other payments
on the debts.
2. Speculative needs: - Cash may be held in order to take advantage of profitable opportunities.
3. Precautionary needs: - Cash may be held to for providing safety against unexpected events.
4. Compensation motive: - Another motive to hold cash balances is to compensate banks for
providing certain services and loans.

Scope (or) Functions of Cash Management:

"Cash management is concerned with minimizing unproductive cash balances, investing excess cash
in temporary avenues and to make the best possible arrangements for meeting planned and
unexpected demands for cash.

1. Cash Planning: Cash planning is a technique, which comprises of planning for and controlling of
cash. It is a management process of forecasting the future needs of cash, its available resources and
various uses for a specified period. A good cash planning aims at providing cash, not only for regular
but also for irregular and abnormal requirements.
[Link] Cash Flows: Cash inflow and Cash outflows are said to be properly managed, if a firm
succeeds in accelerating the rate of cash inflow together with minimizing the cash outflow. As
observed accelerating collections, avoiding unnecessary inventories, improving control over
payments etc. contribute to better management of cash.
3. Controlling the Cash Flows: Cash planning will inevitably be at variance with the results
actually obtained. For this reason, cash controlling becomes essential as it increases the availability
of usable cash from within the enterprise.
4. Optimizing the Cash Level: A financial manager should concentrate on maintaining sound
liquidity position. The foremost need of maintaining optimum level of cash is to meet the necessary
requirements and to settle the obligations well in time.
[Link] Idle Cash: Idle cash or surplus cash refers to the excess of cash inflows over cash
outflows, which do not have any specific purpose. The idle can be invested in short-term marketable
securities, bank depots etc. by considering their returns

Principles of Cash Management:

Harry Gross has suggested certain general principles of cash management that, essentially
improve the efficiency of cash management.

1. Determining Variations of Cash Payments: - Normal and regular payment of cash

leads to small reductions in the cash balance at periodic intervals. Making the payment to different
employees on different days of a week can equalize these reductions. Another technique for
balancing the level of cash is to schedule the cash disbursements to creditors during that period
when accounts receivables are collected at a large.
2. Contingency Cash Requirement: - Contingencies always demand for special cash
requirements that was not estimated and provided for in the cash budget. Large amount of bad
debts, strikes, lockouts etc. are a few among the contingencies. A practical procedure is to protect
the business from such calamities is having insurance coverage, maintaining cash reserves etc.
3. Availing External Cash: - There resources help in providing credit facility to the firm,
which support the firm's objectives of holding minimum cash balance. As such if a firm succeeds in
acquiring sufficient funds from external sources like banks or private financers, shareholders,
government agencies etc., the need for maintaining cash reserves will be reduced.
 4. Maximizing Cash Receipts: - Cash receipts are tackled carefully, results in minimizing
cash requirements of a concern. For this purpose, the comparative cost of granting cash discount to
customer and the policy of charging interest expense for borrowing must be evaluated on continuous
basis.
(A) Concentration Banking: Under this system, a company establishes banking centers for
collection of cash in different areas.
(B) Local Box System: Under this system, a company rents out the local post offices boxes of
different cities and the customers are asked to \ forward their remittances to it. These
remittances are picked by the authorized bank from these boxes to be transferred to the
company's central bank operated by the head office.
(C) Reviewing Credit Procedures: It helps in determining the impact of slow payers and bad
debtors, the accounts of slow paying customers should be reviewed to determine the volume
of cash tied up. Besides this, evaluation of credit policy must also be conducted for
introducing essential amendments.
(D) Minimizing Credit Period: Shortening the terms allowed to the customers would definitely
accelerate the cash inflow side-by-side revising the discount offered would prevent the
customers from using the credit for financing their own operations profitably.

5. Minimizing Cash Disbursements: The motive of minimizing cash payments is the

ultimate benefit derived from maximizing cash receipts. Cash disbursement can be brought under
control by preventing fraudulent practices, serving time draft to creditors of large sum, making
staggered payments to creditors and for payrolls etc.
Cash Management Models
Cash management models analyse methods which provide certain framework as to how the
cash management is conducted in the firm. There are two cash management models which are very
popular in the field of finance.
1. Baumol model
The Baumol model helps in determining the minimum amount of cash that a manager can
obtain by converting securities into cash. William J. Baumol proposed a model similar to EOQ for
cash management.
• The model helps in determining the how much cash should be arranged by selling marketable
securities in each transaction.
• This model assumes that cash can be arranged through selling marketable securities which the
firms hold in the time of needs.
• There are two types of cost involved in holding cash.
• Opportunity cost
• Transaction cost also known as conversion cost
The purpose of the model to minimize the total cost of cash holding which is summation of
opportunity cost and transaction cost. Baumol model of cash management trades off between
opportunity cost/carrying cost/holding cost and the transaction cost.
The Baumol model is based on the following assumptions:
 The firm is able to forecast its cash requirements in an accurate way.
 The firm’s payouts are uniform over a period of time.
 The opportunity cost of holding cash is known and does not change with time.
 The firm will incur the same transaction cost for all conversions of securities into cash.
Cash balances are refilled and brought back to normal levels by the sale of securities. The average
cash balance is C/2. The firm buys securities as and when it has above-normal cash balances.

 C = amount of marketable securities converted into cash per transaction (Economic cash holding size)
• I = interest rate earned on investment in marketable securities
• T = projected cash requirements during the planning period
• b = conversion cost per transaction

2. Miller-Orr model
It is an improvement over Baumol’s model. On the basis of empirical data, Miller and Orr
argued that the cash balances fluctuate randomly, it does not follow a constant consumption rate.
Baumol modes does not talk about treatment of surplus cash balance. The Miller-Orr model is more
realistic than the Baumol model because it accounts for fluctuating cash flows.
The Miller-Orr model helps the businesses to determine optimal cash levels, especially when
facing fluctuating cash inflows and outflows. It establishes upper and lower limits for cash balances,
allowing for random variations within those bounds. When the cash balance reaches the upper limit,
excess cash is invested; when it hits the lower limit, investments are liquidated to replenish the cash
balance.

Spread (Z) = √

Where: T - is the transaction cost of converting marketable securities to cash (or vice versa).
V - is the variance of daily cash flows.
i - is the daily interest rate on marketable securities.
Return Point (RP): RP = Lower Limit + (1/3 * Spread)
Upper Limit (UL): UL = Lower Limit + Spread
INVENTORY MANAGEMENT
Inventories constitute the most significant part of current assets of the business concern. A
proper planning of purchasing of raw material, handling, storing and recording is to be considered as
a part of inventory management. Inventory management considers what to purchase, how to
purchase, how much to purchase, from where to purchase, where to store and when to use for
production etc.
Kinds of Inventories
Inventories can be classified into five major categories.
A. Raw Material B. Work in Progress C. Consumables D. Finished Goods E. Spares
Objectives of Inventory Management
The major objectives of the inventory management are as follows:
• To efficient and smooth production process.
• To maintain optimum inventory levels to maximize the profitability.
• To meet the seasonal demand of the products.
• To avoid effect of price increase of materials in future.
• To plan for procurement of materials, consumables, spares etc.
• To avoid both over stock and under stock of inventory

Techniques of Inventory Management

Inventory management techniques may be classified into various types:

1. Techniques based on the order quantity of Inventories

The business should maintain optimum levels of stock for smooth running of the business
process. Different level of stock can be determined based on the volume of the stock.
 Minimum Level - The business concern must maintain minimum level of stock at all times. If
the stocks are less than the minimum level, then the work will stop due to shortage of
material.
 Re-order Level - Re-order level is the level when the business concern makes fresh order at
this level.
Re-order level=maximum consumption × maximum Re-order period.

 Maximum Level - It is the maximum limit of the quantity of inventories, the business
concern must maintain. If the quantity exceeds maximum level limit then it will be
overstocking.
Maximum level = Re-order level + Re-order quantity – (Minimum consumption × Minimum delivery period)
  Danger Level - It is the level below the minimum level. It leads to stoppage of the
production process.
Danger level=Average consumption × Maximum re-order period for emergency purchase

 Average Stock Level - It is calculated as,

Average stock level= (Minimum stock level + maximum level)/2
 Lead Time - Lead time is the time normally taken in receiving delivery after placing orders
with suppliers. The time taken in processing the order and then executing it is known as lead
time.
 Safety Stock - Safety stock implies extra inventories that can be used when actual lead time
and/ or usage rates are greater than expected.
 Economic Order Quantity (EOQ) - EOQ refers to the level of inventory at which the total
cost of inventory comprising ordering cost and carrying cost are minimized. EOQ can be
calculated with the help of the mathematical formula:

Where, a = Annual usage of inventories (units)

b = Buying cost per order
c = Carrying cost per unit

2. Techniques Based on the Classification of Inventories

 A-B-C analysis - It is the inventory management techniques that divide inventory into three
categories based on the value and volume of the inventories; 10% of the inventory’s item
contributes to 70% of value of consumption and this category is known as A category. About
20% of the inventory item contributes about 20% of value of consumption and this category
is called category B and 70% of inventory item contributes only 10% of value of consumption
and this category is called C category

 VED Analysis - This technique is ideally suited for spare parts in the inventory management.
Inventories are classified into three categories on the basis of usage of the inventories.
V = Vital item of inventories
E = Essential item of inventories
D = Desirable item of inventories
 HML Analysis - Under this analysis, inventories are classified into three categories on the
basis of the value of the inventories.
H = High value of inventories
M = Medium value of inventories
L = Low value of inventories

3. Techniques on the Basis of Records

 Inventory budget - It is a kind of functional budget which facilitates the estimated inventory
required for the business concern during a particular period. This budget is prepared based on the
past experience.
  Inventory reports
Preparation of periodical inventory reports provides information regarding the order level,
quantity to be procured and all other information related to inventories. On the basis of these
reports, Management takes necessary decision regarding inventory control.
 Valuation of Inventories
Inventories are valued at different methods depending upon the situation and nature of
manufacturing process. Some of the major methods of inventory valuation are mentioned
as follows:
1. First in First Out Method (FIFO)
2. Last in First Out Method (LIFO)
3. Average Price Method
4. Base Stock Method
5. Standard Price Method
6. Market Price Method
RECEIVABLES MANAGEMENT
The term receivable is defined as debt owed to the concern by customers arising from credit
sale of goods or services in the ordinary course of business. Receivables are also one of the major
parts of the current assets of the business concerns, it is also known as Accounts Receivables or Bills
Receivables or Trade Receivables.
Receivable management is a process of managing the accounts receivables within a business
organization. Accounts receivables simply mean credit extended by the company to its customers
and are treated as liquid assets. It involves taking decisions regarding the investment to be made in
trade debtors by organization.
The costs associated with the extension of credit and accounts receivables are identified as follows:
A. Collection Cost
B. Capital Cost
C. Administrative Cost
D. Default Cost.
 Collection Cost - This cost incurred in collecting the receivables from the customers to whom
credit sales have been made.
 Capital Cost - This is the cost on the use of additional capital to support credit sales which
alternatively could have been employed elsewhere.
 Administrative Cost - This is an additional administrative cost for maintaining account
receivable in the form of salaries to the staff kept for maintaining accounting records relating
to customers, cost of investigation etc.
 Default Cost - Default costs are the over dues that cannot be recovered.

Factors Affecting the Receivables Size

Receivables size of the business concern depends upon various factors. Some of the
important factors are as follows:
1. Sales Level - Sales level is one of the important factors which determines the size of receivable
of the firm. If the firm wants to increase the sales level, they have to liberalize their credit policy and
terms and conditions. When the firms maintain more sales, there will be a possibility of large size of
receivable.
2. Credit Policy - Credit policy is the determination of credit standards and analysis. It may vary
from firm to firm or even sometimes product to product in the same industry. Liberal credit policy
leads to increase the sales volume and also increases the size of receivable. Stringent credit policy
reduces the size of the receivable.
3. Credit Terms - Credit terms specify the repayment period of receivables, based on the credit
terms, size of the receivables may increase or decrease. Hence, credit term is one of the factors
which affects the size of receivable.
4. Credit Period - It is the time for which trade credit is extended to customer in the case of credit
sales. Normally it is expressed in terms of ‘Net days’.
5. Cash Discount - Cash discount is the incentive to the customers to make early payment of the
due date. A special discount will be provided to the customer for his payment before the due date.
6. Management of Receivable - It is also one of the factors which affects the size of receivable in
the firm. When the management involves systematic approaches to the receivable, the firm can
reduce the size of receivable.

Important Questions

1. Define Working Capital. What are the factors determining working capital of an organization?
2. Explain the different sources of financing working capital needs of an organisation.
3. What is working capital policy? Explain different types of working capital policies.
4. What is cash management? Discuss about scope of cash management.
5. Discuss about various inventory management techniques.
6. Summarize the concept of receivables management.
7. "Depreciation is an important source of working capital". Do you agree? Defend your answer.
8. The board of directors of ABC Engineering Company Ltd. Request you to prepare a statement
showing working capital requirements for a level of activity of 1,85,000 units of production. The
following information is available for your calculation.
Particulars Amount/Unit
Raw Materials 80
Direct Labor 30
Overheads 65
Finished Goods 195
Profits 50
Total Selling Price/Unit 245
Additional Information:
a) Raw Materials are in stock an average of One month.
b) Materials are in process an average of Two weeks.
c) Finished Goods are in stock an average of One month.
d) Credit allowed by suppliers One month.
e) Time lag in payment from debtors Two months.
f) Average time lag in overheads is One month.
g) Average time lag in wages is 1.5 weeks.
h) 20% of the output is sold against cash.
i) Cash in hand is expected to be Rs.60,000.
It is to be assumed that production is carried on evenly throughout the year. Wages and overheads
occurred similarly and a time period of Four weeks is equivalent to a month.
9. A firm sells its products for Rs. 10 per unit of which Rs. 7 represents variable costs. Current
annual sales are Rs.12,00,000 entirely on credit and the average total cost per unit is Rs.9. The
firm is considering a more liberal extension of credit which will result in a slowing process of
average collection period from 1 month to 2 months. This relaxation in credit terms is expected to
produce a 25% increase in sales, that is Rs.15,00,000 annually. Advise the firm regarding
adoption of new credit policy assuming that the firm's required rate of investment is 25%.
10. A company has prepared its annual budget, relevant details of which are reproduced below:
a) Sales Rs.46.80 lakhs 25% cash sales and balance on credit - 78,000 units
b) Raw material cost - 60% of sales value
c) Labour cost - Rs. 6 per unit
d) Variable overheads - Rs. 1 per unit
e) Fixed overheads - Rs. 5 lakhs (including Rs. 1,10,000 as depreciation)
f) Budgeted stock levels:
Raw materials-3weeks
Work-in-progress - 1 week (Material 100%, Labour and overheads 50%)
Finished goods-2weeks
g) Debtors are allowed credit for 4 weeks, Creditors allowed 4 weeks credit
i) Wages are paid bimonthly, i.e., by the 3rd week and by the 5th week for the 1st and
2nd weeks and the 3rd and 4th weeks respectively.
j) Lag in payment of overheads - 2 weeks
k) Cash-in-hand required - Rs. 50,000
Prepare the working capital budget for a year for the company, making whatever assumptions that
you may find necessary.
11. The Board of Directors of Nanak Engineering Company Private Ltd. requests you to prepare a
statement showing the Working Capital Requirements for a level of activity of 1,56,000 units of
production.
The following information is available for your calculations:
Per unit (Rs.)
a) Raw material 90
Direct labour 40
Overheads 75
205
Profit 60
Selling price per unit 265
 Raw materials are in stock, on average one month.
 Materials are in process, on average 2 weeks.
 Finished goods are in stock, on average one month.
 Credit allowed by suppliers, one month.
 Time lag in payment from debtors, 2 months.
 Lag in payment of wages, 1 ½ weeks.
 Lag in payment of overheads is one month.
 20% of the output is sold against cash. Cash in hand and at bank is expected to be
Rs.60,000. It is to be assumed that production is carried on evenly throughout the year,
wages and overheads accrue similarly and a time period of 4 weeks is equivalent to a
month.
12. A proforma cost sheet of a company provides the following particulars.
Elements of cost:
Material – 40% Direct Labour - 20% Overheads – 20%
The following further particulars are available:
a) It is proposed to maintain a level of activity of 200000 units.
b) Selling price is Rs. 24 per unit.
c) Raw materials are expected to remain in stores for an average period of one month"
d) Materials will be in process on average half a month.
e) Finished goods are required to be in stock for an average period of one month.
f) Credit allowed to debtors is 2 months.
g) Credit allowed by suppliers is one month. You are required to prepare a statement of
working capital requirements, if desired cash balance is Rs. 2,00,000.
 13. Prepare an estimate of working capital requirement from the following information.
Annual sales: 1,00,000 units;
Selling price: Rs. 8 per unit.
Percentage of net profit on sales - 25%;
Average credit allowed to customers: 8 weeks;
Average credit allowed by suppliers - 4 weeks;
Average stock holding period - 12 weeks;
Allow 10% for contingencies.
14. X. Limited sells a product at a gross profit of 20 percent on sales. The following details are
extracted from the annual records of the company for the year.
Amount (Rs.)
Sales (3 moths credit) 60,00,000
Raw Materials 18,00,000
Wages (15 days in arrears) 9,60,000
Manufacturing expenses (one month in arrears) 12,00,000
Administrative expenses (one month in arrears) 4,80,000
Sales promotion expenses payable half yearly in advance) 12,00,000
Income Tax (Last quarter installment due) 4,00,000
The company enjoys one month credit from the suppliers of raw material and maintain two months
of stock of raw materials and one month of finished goods. Cash balance is maintained at Rs.
1,00,000.
Calculate its net working capital.
15. On April 1st of the current year the board of directors of ABC limited wishes to know the amount
of working capital that will be required to meet the program of activity. They have planned for
the year 1 is available.
a) Production during the present year was 60,000 units. It is planned that this level of
activity should be maintained during the next year.
b) The expected ratio of cost to selling price is
Raw Material: 60%
Direct Wages: 10%
Overheads: 20%
c) Raw material is expected to remain in stores for an average of 2 months before this
are issued for production.
d) Each unit of production is expected to be in process one month. Full unit of raw
material is required in the beginning of production
e) Furnished goods will stay in warehouse for approximately 3 months
f) Creditors allow credit for two months from the date delivery of raw material
g) Credit allowed to debtors is 3 months from the date of dispatch
h) There is regular production and sales cycle, Selling price per unit is Rs.5
Prepare Working Capital Forecast under net working capital method.
16. JKL Limited is considering the revision of its credit policy with a view to increasing its sales and
profit. Currently all its sales are on credit and the customers are given one month's time to
settle the dues. It has a contribution of 40% on sales and it can raise additional funds at a cost
of 20% per annum. The marketing manager of the company has given the following options
along with estimates for considerations:
Particulars Current Position Option I Option II Option III
Sales (in Lakh Rs.) 200 210 220 250
Credit period (in months) 1 1.5 2 3
Bad debts (% of sales) 2 2.5 3 5
Cost of credit administration((in Lakh Rs.)1.20 1.30 1.50 3.00
You are required to advise the company for the best option.
17. A proforma cost sheet of a company provides the following particulars:
Amount per unit (Rs.)
Raw material 80
Direct labour 30
Overheads 60
Total cost 170
Profit 30
Selling price 200
The following further particulars are available.
 Raw materials are in stock on an average for one month, WIP on an average for half a month.
Finished goods are in stock on an average for one month.
 Credit allowed by suppliers is one month, credit allowed to customers is two months.
 Lag in payment of wages is 1½ weeks (1.5), lag in payment of overhead expenses is one
month.
 One-fourth of the output is sold against cash, cash in hand and at bank is expected to be
Rs.25,000.
 You are required to prepare a statement showing the working capital needed to finance a level
of activity of 1,04,000 units of production. You may assume that production is carried on
evenly throughout the year, wages and overheads accrue similarly and a time period of 4
weeks is equivalent to a month.